What is a Shareholders’ Agreement?

A shareholders’ agreement definition states that it is a contract between the shareholders of a company and the company itself.

Also known as a shareholders’ agreement, is an arrangement that regulates the relationship between the shareholders, the management of the company, ownership of the shares, rights, obligations, and protection of the shareholders. It may also command the way in which the company is run.

Purpose of a Shareholders’ Agreement

The purpose of the shareholders’ agreement is to treat shareholders fairly, while safeguarding their rights. The agreement helps protect current shareholders from mistreatment by any future management. It is largely about preparedness in times of market uncertainty.

The shareholders’ agreement is vital for the following reasons:

• It gives structure to significant decisions made in the company
• It puts forth the rights and obligations of the shareholders
• It defines the company operations and defines the different roles of a shareholder
• It brings about regulation for purchasing and/or sale of shares
• It takes the role of a protective shield to the minority shareholders against potential market risks
• It defines and regulates the relationship between the company and its shareholders
• It paves the way for easy dispute settlement, thereby saving money, time, and energy

Contents of a Shareholder's Agreement

Now that you have a grasp of what a shareholders’ agreement is, let’s take a closer look at the contents of the agreement.

• Parties: The first section defines a company as a party, other than its shareholders.
• Board of directors: It outlines the role of the board of directors of the company. A majority vote is necessary to approve the board's decisions. Additionally, it also specifies how often the board must meet, and the manner in which they are elected and replaced.
• Reserved matters: The agreement must state matters that cannot be passed without getting the approval of all signatories. All shareholders are allowed to review particular transactions to determine if they are detrimental to their interests. Some of the items generally withheld include changes in capital, acquisition or disposal of certain assets, acquisition of new liabilities, payment of dividends, etc.
• Shareholder information and meetings: This clause stipulates that shareholders have the right to receive regular updates on company performance through quarterly and annual reports. It must also specify the time, date and place of the general meeting of shareholders.
• Share capital and transfers: The agreement must reflect the company's authorized capital at the date of signature. It also contains provisions regarding transfers of shares for certain circumstances such as the death of a director or shareholder.
• Amendment and termination: The agreement must specify the procedures for amending or terminating the same.

Risks in Shareholders Agreement

While the shareholders’ agreement meaning is largely protective. However, in some countries some risks come along with it. These include:

• Using shareholders’ agreements may lead to partnerships that could have unintended tax consequences or otherwise lead to liability in case of bankruptcy.
• If the shareholders' agreement is inconsistent with the constitutional documents, the effectiveness of the agreement may be undermined.
• In countries where there is a notarization process, if the notary fee is set based on the value of the item, the parties may impose an excessively high notary fee on the contract, which may render the contract unenforceable if it is not paid.
• Under certain circumstances, shareholders’ agreements may be presented as evidence of collusion and/or monopoly practices.

How it protects minority shareholders

Minority shareholders lack voting rights in the company, and potentially have minimal impact on the management of the company. The Articles of Association protect minority shareholders. However, such provisions are often amended by special resolutions of majority shareholders. An agreement can bridge these gaps by requiring that major corporate decisions, regardless of voting rights, must be approved by all shareholders. Such rules keep the majority shareholders in check not to invalidate minority shareholders in certain decisions, such as: Issuance of new shares, new corporate bonds, etc.

How it protects majority shareholders

Shareholders’ agreements can also protect majority shareholders if the minority is not cooperative. In addition, such agreements may include provisions prohibiting minority shareholders from transferring their shares to competitors or other parties.

Example of a Shareholders Agreement

Let’s consider a shareholders’ agreement for an entrepreneurial venture. Many entrepreneurs running a startup find it wise to draft a shareholders’ agreement for the original parties involved – to clarify what the parties originally intended. As the company matures and changes, if disputes arise, a written agreement can serve as the starting point and help resolve the issue.

They can also specify who can become shareholders, what happens when a shareholder is no longer able to actively own their shares (becomes disabled, dies, resigns, or is terminated), and who can become a member of the board of directors.

A shareholders’ agreement for a startup often includes the following sections:

• A preamble, identifying the parties
• A list of clauses – rationales and goals for the clauses
• Detailed information on the company's elective and mandatory shares repurchase in the event of a shareholder exercising their right to give up their shares
• A right of first refusal clause, detailing how the company has the right to acquire the selling shareholder's securities before it is sold to a third party
• Notation of a fair price for shares
• A possible description of an insurance policy

Final word

Thus a shareholders’ agreement proves to be an essential document that defines the relationship between shareholders and the company. It safeguards the rights and obligations of the majority and minority shareholders, and it ensures all shareholders are treated fairly.