Why is a shareholder agreement important for your startup?

Tips & Tricks

Getting started

So, you’ve thought about starting up your own business for a long time and you are finally making that dream a reality. Drawing up a shareholder agreement may not be your number one priority when you sit down with your new business partners to decide on where to start.

You may also see it as giving the impression of mistrust between business partners at the very start of your venture. However, it is crucial in safeguarding the future of both your new start-up company and the shareholders who have formed it.

What is a shareholder agreement?

A company is not legally obliged to draw up a shareholder agreement. However, it is highly recommended for companies with more than one shareholder. The agreement governs how a company is run and offers protection to the shareholders should something unexpected happen, including disputes, or the ill health, death or departure of a shareholder from the company. The purpose of the agreement is to protect the investment and interests of all shareholders.

Ideally, a shareholder agreement should be set up when a company is first formed. This minimises the associated administrative costs and ensures that the shareholders are in agreement on the direction of the business from the outset. The agreement should be routinely reviewed to ensure that it continues to meet the needs of the shareholders. It should also be reviewed at a time of business growth or merger with another firm.

A shareholder agreement can be between some, or all, shareholders in the company. The agreement will set out rules as to how the company operates and the relationship between shareholders. This will be especially beneficial to minority shareholders. For example, the agreement could ensure that a minority shareholder has a say in the appointment of new directors, the sale of shares and any borrowing activity.

The agreement could also offer protection to majority shareholders by compelling a minority shareholder to sell their share in the company if they seek to prevent the majority shareholder from doing so. For equal split partnerships, the agreement can set out in advance how disputes will be settled.

What should a shareholder agreement include?

A shareholder agreement should set out how shareholders can sell their shares; how to prevent shares being bought by undesirable investors; and what happens to shares upon the death of a shareholder. It should protect minority shareholders and ensure they have a say in important decisions.

The agreement should set out how the company will be run, including the hiring and termination of directors, business growth and direction, financial expenditure and borrowing. Lastly, it should set out how disputes will be settled.

Shareholders may be tempted to put off the task of drawing up a shareholder agreement when the company is first created. They may feel that both time and money are better spent focusing on sales, business growth, turning a profit and meeting tax and legal obligations.

However, if disputes arise once your business is up and running, it could prove difficult to find a path forward without a pre-defined way of resolving issues. This could potentially lead to failure of the business. You should always seek advice from a legal professional as early as possible to ensure that the company is correctly structured for the benefit of all concerned.