When assisting new startup companies I often hear the phrase ”I don’t think we need a shareholders’ agreement, we already discussed how we’re going to deal with things”. Indeed, very often this is the case; the ownership of the company is divided equally, Matt takes care of the sales, Andy handles the coding and Kate is responsible for securing financing. At this phase however a business lawyer’s head is filled with series of “What if” questions. What if Matt transfers to work for the competitor, Kate wants to sell her shares, or if Andy lashes out due to the aforementioned and decides that he wants to sell “his own code” to Google?
Shareholders’ agreements are drafted exactly for these ”What if” and “What next” situations. A shareholders’ agreement is an agreement between the shareholders of the company, which stipulates the ways to manage and decide upon company matters. By the provisions of the shareholders’ agreement the voting behavior of, the composition of and possible changes to the shareholders can be effectively controlled. What is even more important, possible changes are easily managed when there is a prior mutually agreed procedure in place for these scenarios.
The shareholders’ agreements should always be tailor-made for each individual company and its respective shareholders’ needs. One of the most essential matters to be agreed upon in the shareholders’ agreement are the transfer and restriction to the transfer of shares, as well as securing the business idea and other intellectual property rights to the company.
Restricting the transfer of shares during a certain period of time is typical, and it can be tied to a certain group of people. Typically also the valuation or the means to calculate the value of the shares in transfer situations are agreed on in the shareholders’ agreement. It is easier to reach a common understanding regarding the sale of Kate’s shares, when the transfer price and other restrictions to the transfer have already been agreed to. Through the provisions of the shareholders’ agreement it is also possible to secure the right to retain a certain ownership percentage to a specified group of people. A demand for this kind of anti-dilution protection may become topical for example once new rounds of investments are received.
In addition to transfer restrictions it is often practical to restrict the competition of shareholders with the company and agree on confidentiality provisions. It may not necessarily be optimal, that Matt has acted as the spearhead regarding the company’s sales, knows the product and assets inside out and transfers to be the sales representative for the competitor. In an exit situation of an individual shareholder it may also be practical to set an obligation for the respective shareholder to transfer the shares to the company or the other shareholders.
Already starting from the first steps of the company’s life cycle, from the perspective of the shareholders and taking into account a possible upcoming M&A procedure, securing the intellectual property rights of the company is extremely valuable. Often a company’s value is based on a specific invention and a business created around it. Without a separate agreement, the program coded by Andy is not necessarily transferred to the company’s IPR-pool, in which case the business might suffer a blow when the code and a software based on it transfers to Google’s possession.
It is noteworthy, that the above-mentioned and other key matters concerning the corporate governance, distribution of assets and transfer of shares can be regulated by among other things the limited liability companies act and the articles of association. Compared to the publicly available articles of association, the shareholders’ agreement is generally kept as a confidential document, the content of which is known solely by the parties to the agreement. Consequently, the shareholders’ agreement typically provides for considerably more detailed provisions, than those contained in the articles of association, and matters which may deviate from the articles of association. However, the matters cannot be agreed by the shareholders’ agreement in contradiction of mandatory law – at least not with binding effect on the parties. Thus, when drafting the shareholders’ agreement or agreeing for example on the distribution of assets provisions of mandatory law should be taken into account.
A professionally drafted shareholders’ agreement provides for a secure and appealing basis for a possible M&A transaction and the landing of a new investor. In my opinion shareholders’ agreements create stability for the company’s day-to-day operations and allows you to focus on the essential – the business itself.