Importance of shareholder agreement for a start-up venture

April 1, 2022

Shareholders’ Agreement – An Introduction

Before we dive into the importance of shareholder agreement, what is a shareholder agreement? A shareholder’s is a legal contract done privately amongst the shareholders of a business, even a start-up. It describes the regulations and rule sets towards the definition of policies, processes, and procedures for the apt functioning of the company. 

This agreement is useful in regulating the work-and-business flow between the key stakeholders since this document needs to reflect a synchronized understanding between the investors/founders of the company. 

Furthermore, this agreement is helpful in the long run for business success. The Shareholder’s agreement is different from an AoA (Articles of Association) which is a statutory document that needs to be filed under the Companies Act

Since this agreement need not be filed as part of the Companies Act to any third party or Government, this agreement could remain confidential till if any disputes arise as per the agreed norms. 

The main purpose of the Shareholders Agreement is to protect the shareholders’ financial significance and importance.

Though like any other agreement, the Shareholders Agreement needs to be drafted by a legal professional; however, this agreement is a collection of points that would describe what action needs to be taken based on a situation. Some of the situations that may arise could be like below:

1. A founder who would want to leave the company voluntarily 

2. A founder who passed away

3. A founder who cannot participate due to an illness 

4. The institution may need financial support and would like to invite a new partner.

5. The institution may generally need a new partner.

6. A founder may need to be removed due to various reasons like Quid-Pro-Quo or on moral grounds or anything else.

Importance of shareholder agreement

The shareholder agreement could be modified as it is required from time to time, based on all key stakeholders’ consent. As the business grows from the time the start-up company got incorporated, there could be modifications that may be deemed fit or a few more conditions may need to be added. 

A shareholders’ agreement is an important document, particularly for the start-up institution. 

The primary reason being one could use it to anticipate some aspects that may have serious impacts on the functioning and growth of the company. One of the importance of shareholder agreement is to forecast those criteria and regulate them through a proper mitigation process. The clear definitions of what-if and how-to will provide a path-way to overcome the problems with actionable points of work-flow that regulates how this problem(s) can be fixed and what actions will have to be taken to solve it.

Ultimately, the importance of shareholder agreement is to set the rules for all the parties involved in the company, be it founders or investors. The only way to achieve this goal is to reach an agreement that will have to be included in a legal document that will be binding for all parties.

Setting the rule sets is one thing that is for the importance of shareholder agreement; Roles, Responsibilities in conjunction with Accountability are the other areas that are equally important. The Agreement document will set the rules keeping all the parameters with clear actionable points so that the correct path could be enforced for the company’s growth. Otherwise, without the proper draft of the Shareholder Agreement, it may lead to a negative effect on a given scenario which may arise ad hoc.

Categories of the Agreement

There are mainly three categories of a Shareholder Agreement.

The first is Seed Stage followed by the Early Stage and then Growth Stage.

As the name signifies Seed Stage is when the Shareholders Agreement is done right at the embryo stage. When the company is about to kick off the Agreement that is in place, it explains the basic steps on equities, stakes, financial and other types of contributions between the founders, roles, responsibilities, and accountability of the stakeholders. The regulations on basic steps could be defined and kick-off.

In the Early Stage, the start-up would have been formed for a little time and the agreement could be modified to the next levels of goals and achievements towards the growth of the company. There could be more what-ifs analyses and proper modifications could be made to regulate the procedure with all parties’ consensus.

In the Growth Stage, the business model would be matured as the start-up would have become grown-up. Here there may be more challenges for the company in terms of cash flow; infusion of the fund; expansion of territories etc. which may introduce more challenging What-If scenarios. Here, the Agreement could be further modified to include those criteria and could be enforced with all stakeholders’ consensus. This way, as the company grows, the Shareholder Agreement could be modified for the betterment of the company and all stakeholders could align their thoughts toward the vision and mission of the company. 

It is always advisable to hire a lawyer to draft a shareholder agreement, whether the company is small or big. Self-made shareholder agreements can lack appreciation and sometimes, will not contain the legal jargon necessary for them to be legally binding and enforceable. This can hurt your opportunities, financial capital, and other components. 

What does a Shareholders Agreement talk about?

The document outlines the rights and responsibilities of the shareholders. The legally binding agreement should be specific and unambiguous to avoid disputes. 

Of course, agreements can be customized to fit the needs and preferences of the cooperation – but the basic points of an agreement must be mentioned. These points or components define the business’ vision, how it will be run, the process of resolution, and the benefits to the shareholders. 

The information that has to be covered are: 

  • Preamble: company name and shareholders. 
  • Goals: end-goals of the agreement must be stated
  • Date: When is the agreement getting executed? 
  • Number of Shares: How many shares are being issued? 
  • Ownership: Percentage of ownership of each shareholder. 
  • Share Transfer: The process of buying, selling, and transferring shares. How will the shares be transferred during an untimely death of a shareholder? 
  • Voting: How are votes decided? 
  • Share Creation: How are the shares created? 
  • Shareholder Protection: How are the shareholders protected? 
  • Dividends: How are the dividends paid? When will they be paid? 
  • First Refusal: The refusal clause. 
  • Price: Price of shares. 
  • Operations: How the company will operate – when directors are removed, how are board meetings conducted, information with regards to management, banking arrangement, and financial details. 
  • Dispute Resolution: Resolution process – how will it be initiated and conducted? 

The lawyer will ensure that the shareholder agreement contains all the necessary requirements/conditions and details so that the document protects the shareholders, the company, and is legally binding and enforceable. 

Contact eSahayak to know more about the importance of shareholder agreement. Get your queries clarified today. 

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