10 key things to include in your shareholders’ agreement

A shareholders' agreement provides for how a company should be run, and governs the relationship between the shareholders of a company. The document provides the opportunity to put into writing how you want your company to be run, but also what should happen if things don’t go to plan.

1. Funding

The relative amount of funds each shareholder wants to put into the company and the relative proportion of shares to be held should be agreed up front.

Shareholders may also lend funds to the company. A discussion would be required as to whether each loan should have certain rights (which can be different for each) such as:

  • interest rate
  • monthly repayment amount
  • right to convert into shares
  • any other rights

You should also consider establishing an employee share option scheme to motivate key people.

2. Pre-emption rights

All shareholders should have the right to invest in future funding rounds to avoid being diluted. This does not mean shareholders have to put more money in, but if they want to and are able to, they have that right to maintain their ownership in any future funding round.

3. Leaver shares

An investor may leave the company. Shares may be subject to reverse vesting - commonly shares are earned monthly over 3 years meaning, for example, that if a holder leave after 12 months, the company has the right to buy back two-thirds of the relevant shares.

4. Right of first refusal and co-sale

If any shareholder wants to sell the shares to someone else, other investors should have the option to buy those shares on the same terms or to sell their shares, again on the same terms.

5. Drag-along

If shareholders owning more than usually a majority of the shares want to sell their shares (typically to accept an acquisition offer) then, as long as the Board of Directors and a majority of the investors approve it, all other shareholders must also sell their shares. This protects all shareholders from, say, one shareholder refusing to sell the shares in an acquisition offer and blocking a deal everyone else wants to see happen.

6. Liquidation preference

If the company is sold, shareholders should get the higher of the amount of invested or the ownership percentage of the sale value.

In the worst case if the company is wound down with very little left, then anything left would be distributed in proportion to the shares held.

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7. Board of Directors

The Board of Directors runs the company. Investors need to think about who will be a director and whether decisions have to be unanimous or by a majority. You may consider whether a less formal observer, non-voting position would be useful on the board.

8. Important decisions

Usually the approval by a majority of investors is required for the important decisions. These might be to:

  • create any fixed or floating charge, lien (other than a lien as arising by operation of law) or other encumbrance over the whole of any part of its undertaking, property or assets, except for the purpose of securing indebtedness to its bankers for sums borrowed in the ordinary and proper course of the business and on arm’s length terms;
  • give a guarantee or indemnity to secure liabilities or obligations of any person;
  • other than any expenditure set out in any approved business plan, enter into any material contract or purchase, hire, lease or enter into any finance arrangement to acquire any material asset or, sell, transfer, lease, assign or otherwise dispose of a material part of its undertaking, property, intellectual property or assets (or any interest in them), or contract to do so otherwise than in the ordinary and proper course of the business;
  • issue any shares or debentures or create any new shares, or issue securities convertible into shares or debentures (except for customary exceptions);
  • issue options from a share option scheme;
  • alter the rights attaching to any class of shares;
  • consolidate, sub divide or convert or buy-back any share capital;
  • alter the articles of association or adopt or pass any resolutions inconsistent with them;
  • do or permit to be done any act or thing whereby the company may be wound up (whether voluntarily or compulsorily);
  • enter into a contract or transaction except in the ordinary and proper course of the business on arm’s lengths terms;
  • appoint or remove any director, except in accordance with the rights conferred on the investors;
  • incur any material indebtedness;
  • instigate, defend, settle or compromise any litigation (other than debt collection in the ordinary course of business);
  • enter into any agreement or arrangement in the nature of partnership, consortium, joint venture (where such joint venture requires the incorporation of a joint venture vehicle or other equity commitment by the company) or profit sharing arrangement, or the amalgamation with any other person (other than as part of a solvent reconstruction);
  • effect a sale, transfer or disposition of or encumbering any of its intellectual property (other than on an arms’ length basis and in the ordinary course of business);
  • enter into a contract to acquire or dispose of all or a material part of any business, including that of the company;
  • expand, develop or evolve its business otherwise than through the company or a wholly owned subsidiary of the company; or
  • dispose of or acquire any interest in any share in the capital of any company or incorporate any new subsidiary undertaking.

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9. Restrictive covenants

Shareholders should be restricted from starting a competitive business or leave and take employees to another business even if it is not competitive. These restrictions apply for as long as a person is employed or hold at least say 10% in shares and for at least one year after that.

You should check that relevant employees have signed employment contracts which clarifies that the company owns all of the intellectual property that has been created.

10. Information rights

Shareholder should have rights to obtain financial and other information in relation to the business.

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