What is a shareholders' agreement?

A shareholders' agreement is a legally binding contract between the shareholders of a company. It outlines how a company will be run, the decision-making processes, transfer of shares, dispute resolution, and exit strategies, as well as ownership percentages.

Parties to a shareholders’ agreement

Shareholders and new shareholders, via the deed of adherence, are subject to the agreement. In some cases, the company itself, directors, heirs, estate administrators, and transferees can be parties to shareholders’ agreements, too.

A deed of adherence

In the context of shareholders' agreements, a deed of adherence is a legal document that allows a new shareholder to "sign up" or adhere themself to an existing shareholders' agreement without having to create a whole new agreement. 

When a new shareholder joins and signs a deed of adherence, the new shareholder agrees to follow the same rules as the existing shareholders

Minority shareholders in shareholders’ agreements

A shareholders' agreement is key for minority shareholders who have limited protections under law as it protects them against unfair treatment or dilution of their stake. The agreement helps to balance power between majority and minority stakeholders. We’ll go over this in more detail below.

Shareholders' agreement components

Date

The date specifies when the agreement becomes effective, typically the day it's signed by all parties.

Number of shares issued 

This component outlines the total number of shares the company has issued, providing clarity on the company's overall ownership structure.

Capitalization table of shareholders and ownership

The capitalization table details each shareholder's ownership percentage and the number of shares they hold, offering a clear snapshot of the company's ownership distribution.

Restrictions on transferring shares 

This section outlines any limitations or procedures that must be followed when shareholders want to sell or transfer their shares, often including rights of first refusal for existing shareholders.

Pre-emptive rights of current shareholders

Pre-emptive rights give existing shareholders the first opportunity to purchase new shares issued by the company, allowing them to maintain their proportional ownership.

Payment details if the company is sold

This component specifies how proceeds from a company sale would be distributed among shareholders, ensuring clarity and fairness in the event of a liquidity event.

What does the shareholders' agreement regulate?

Voting during shareholder meetings

A shareholders' agreement typically regulates voting during shareholder meetings. It specifies which shareholders have voting rights, outlines methods to cast votes, and defines majority requirements. It can also regulate how deadlocks are resolved during evenly split votes and grant some shareholders special voting rights to make certain decisions.

Buying or selling company shares

A shareholders' agreement typically regulates the buying and selling of company shares. Depending on what it states, it can protect the interests of shareholders by forbidding shareholders from transferring shares without prior written consent from other shareholders. 

A shareholders’ agreement can also grant a right of first refusal to existing shareholders and establish a method for valuing shares. Additionally, it can include terms for buying out a shareholder's shares in specific circumstances.

The corporation's articles of incorporation or bylaws

A shareholders' agreement is designed to complement the company's articles of incorporation and bylaws. It provides additional governance structures and rules that work alongside the formal corporate documents. 

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Many shareholders' agreements include a "supremacy clause" which states that in the event of a conflict between the agreement and the articles of incorporation or bylaws, the provisions of the shareholders' agreement will prevail.

Selection of board members

The agreement can specify which shareholders or groups of shareholders have the right to appoint directors to the board. It can establish the qualification directors must meet, how many directors the corporation can have, the term limits and rotation, and when and how directors are appointed.

Shareholders' agreement benefits

Protecting minority shareholders

Shareholders' agreements protect minority shareholders by establishing specific rights that go beyond standard legal protections. For example, a shareholders’ agreement can include tag-along rights, which allow minority shareholders to join when a majority shareholder sells their shares, giving minority shareholders the opportunity to sell their own shares on the same terms and conditions. 

The agreement can also allow minority shareholders to veto powers on key decisions, ensuring that minority shareholders have a voice in company operations and are protected from potential oppression by majority shareholders.

Regulating the transfer of shares

A shareholders' agreement typically regulates the transfer of shares by imposing restrictions and setting out specific procedures that must be followed when a shareholder wishes to sell or transfer their shares. 

These provisions often include rights of first refusal for existing shareholders, pre-emptive rights, tag-along, and drag-along rights, as well as mechanisms for valuing shares, all designed to maintain control over who can become a shareholder and protect the interests of remaining shareholders.

Setting out the rights of shareholders

In addition to protecting minority shareholders and regulating the transfer of shares, a shareholders’ agreement acts as a rule book for instances when disputes need to be resolved. 

Types of shareholder agreements

There are three main types of shareholder agreements. Each is defined by the relationship between the buyers and sellers of shares when trigger events occur and has its own set of advantages and considerations. A company can decide which one to choose based on its specific needs and circumstances.

Cross purchase

A cross purchase agreement is when shareholders agree to buy each other's shares if one of them leaves the company due to death, retirement, or other reasons. This type of agreement is often funded by life insurance policies that each shareholder takes out on the others, with the proceeds used to purchase the departing shareholder's stake.

Entity purchase

An entity purchase agreement, also known as a stock redemption agreement, involves the company itself buying back the shares of a departing shareholder. This type of agreement simplifies the process by requiring only one life insurance policy per shareholder (owned by the company) and centralizes the buyout process through the business entity.

Hybrid purchase

A hybrid purchase agreement combines elements of both cross purchase and entity purchase agreements, offering more flexibility to the parties involved. It typically allows either the remaining shareholders or the company to purchase the departing shareholder's stake, depending on the circumstances at the time of the triggering event.

How to create a shareholder agreement

Let’s go over general steps to create a shareholder agreement. 

1. Gather essential information, including names and details of all shareholders, the number of shares each owns, and the company’s basic financial and operational information. 
2. Outline key elements specific to the company, such as shareholder rights and obligations, the decision-making process, the share ownership and transfer rules, the profit distribution policies, the dispute resolution mechanisms, and the exit strategies.
3. Define each shareholder’s rights and responsibilities.
4. Address scenarios and include provisions for situations that may arise, such as share transfers and disputes, or the death or departure of a shareholder.
5. Draft the agreement in clear, straightforward language to avoid misunderstandings. 
6. Consult with an attorney to make sure that there are no loopholes in the agreement. (Steps 5 and 6 can be swapped, depending on your preference for when you want to involve the corporate lawyer.)
7. Review the agreement with all shareholders and negotiate any terms.
8. Finalize the document. 
9. Have all the shareholders sign the agreement.
10. Review and update the agreement regularly to keep it up to date.

FAQs about the shareholders' agreement

What's the difference between the articles of incorporation vs. a shareholders' agreement?

The articles of incorporation is a public document that makes the company legitimate and provides basic information about it. A shareholders' agreement, on the other hand, is like a private rulebook that the company owners (shareholders) create to manage their relationships and how they'll run the company together. 

While every company must have articles of incorporation, a shareholders' agreement is optional but very useful, especially for companies with multiple owners who want to define their rights and responsibilities.

What should a shareholder agreement include?

A shareholders' agreement is essentially a comprehensive rulebook for company owners, covering everything from how decisions are made and profits shared to what to do if someone wants to sell their shares or if someone decides to leave the company. 

It's designed to prevent misunderstandings, protect everyone's interests, and provide clear guidelines for running the business, much like a detailed playbook that helps all shareholders know what to expect and how to handle situations that might arise.

How do I make a shareholder agreement?

To make a shareholders' agreement, start by gathering essential information about the company and shareholders, then outline key elements such as ownership rights, decision-making processes, share transfer rules, and dispute resolution mechanisms. 

While you can draft an initial outline, it's highly recommended to work with an attorney to ensure the agreement is comprehensive, legally sound, and tailored to your specific business needs. This document will serve as a vital rulebook for managing shareholder relationships and company operations.

What are the pitfalls of shareholder agreement?

Shareholders’ agreements, while beneficial, can have significant drawbacks including reduced flexibility once signed, potential overprotection of minority interests, and difficulties in reaching consensus among multiple shareholders. 

Shareholders’ agreements can also complicate share transfers, deter potential buyers, and increase legal costs, especially if not drafted carefully. Poorly constructed agreements may lead to conflicts, create imbalances between shareholders with different financial positions, and potentially foster a hostile environment.

How binding is a shareholder agreement?

A shareholders' agreement is legally binding on all parties who sign it, and can be enforced in court if any signatory breaches its terms. However, unlike a company's constitution, which automatically binds all shareholders, a shareholders' agreement only binds those who are parties to it, meaning new shareholders would need to explicitly agree to its terms to be bound by them.

Who draws up a shareholders agreement?

A shareholders' agreement is typically drawn up by legal professionalswho have expertise in drafting these complex documents. While shareholders can outline their desired terms, it's highly recommended to have the agreement professionally drafted and reviewed to ensure it's legally binding, comprehensive, and protects all parties' interests effectively.

What happens if you don't have a shareholders agreement?

Without a shareholders' agreement, a company may face significant challenges such as disputes over decision-making, lack of protection for minority shareholders, and difficulties in resolving conflicts or managing share transfers. 

Not having a shareholders’ agreement can lead to uncertainties in business operations, potential legal battles, and even the risk of company dissolution if shareholders cannot agree on important matters.

What is the basic shareholder agreement?

A basic shareholders' agreement typically covers share ownership and transfers, decision-making processes, dispute resolution mechanisms, and exit strategies.

Conclusion: Make finances frictionless with Rho

The bottom line is that a shareholders’ agreement is an essential guidebook for a corporation as it outlines roles, responsibilities, transfer of shares, and decision-making processes.  

As you dot the i’s and cross the t’s in your shareholders’ agreement, consider using Rho as your company’s finance platform. Rho allows you to open business accounts with no minimum balances and no monthly fees. It also offers free domestic wires, same-day ACH transfers, and international USD wires at no cost. 

Rho can be suitable for a vast range of companies—from two-person startups to publicly traded enterprises.

Find out more about Rho here.

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Note: This content is for informational purposes only. It doesn't necessarily reflect the views of Rho and should not be construed as legal, tax, benefits, financial, accounting, or other advice. If you need specific advice for your business, please consult with an expert, as rules and regulations change regularly.