This is what to look for in a shareholder agreement

What to look for in a shareholder agreement

This is not a legal advice, rather a hands-on indication what to look for in a shareholder agreement. As an entrepreneur you need to understand what you sign, or you will be surprised.

Basic content to look for in a shareholder agreement

All shareholder agreements shall include basic information such as:

  • Date of signing of the agreement.
  • Capitalization table that list shareholders and their percentage ownership.
  • Total number of shares in the company.

Share transfer provisions to look for in a shareholder agreement

It’s in all shareholders interest to agree on share transfer provisions, regulating what happens at share transactions in the company.

There are 5 share transfer provisions you shall look for in a shareholder agreement:

  1. Pre-emptive rights means that all existing shareholders have the right to buy additional shares at any new share issue. The reason is to protect each shareholders ownership percentage.
  2. Right of first refusal means that existing shareholders have a priority in a transaction, for example a new share issue. Pre-emptive rights and right of first refusal are very similar. Be cautious about subtle wordings.
  3. Tag along rights gives minority shareholders the right to join a share sell transaction that a majority shareholder makes. Tag along rights is a minority shareholder protection. This is an important provision to look for in a shareholder agreement.
  4. Drag along right gives the majority shareholder the right to force minority shareholders to sell their shares when the majority shareholder exit. Venture capital investors request this provision to a shareholder agreement to ensure their exit will not be complicated by others. This is a very important provision to look for in a shareholder agreement, as a founder.
  5. Shotgun provision is a buy-sell provision that regulate what happens when a shareholder whish to leave the company. A shotgun situation may occur at major disagreements between shareholders on company direction. This provision is common in the USA and its important to look for in a shareholder agreement.

There shall be dates specified in all 5 share transfer provisions. Meaning that when someone exercise any of the provision, the clock starts ticking. You shall regulate for how many days a provision shall be valid before its void.

These 5 share transfer provisions are important to look for in a shareholder agreement. Read them carefully.

Share value issues to look for in a shareholder agreement

There shall be a provision in your shareholder agreement that regulate how shares shall be valued in different situations.

This provision you need to look for in a shareholder agreement. Founder’s sometime overlook this provision and take things for granted.

Business provisions to look for in a shareholder agreement

There are 4 business provisions to look for in a shareholder agreement:

Decision-making

The decision-making clause is important to look for in a shareholder agreement. Founders are often surprised how quickly their power is sometimes undercut by outside investors.

Typically, there are 6 decision-making provisions in a shareholder agreement:

  1. Hiring of employees –shareholders like to influence priorities, timing and spending.
  2. Entering into major agreements – prohibiting unplanned actions or obligations.
  3. Borrowing money – controlling priorities and future options.
  4. Pledging corporate assets – controlling ownership and future options.
  5. Issuing of shares – defending ownership and controlling future options.
  6. Paying dividends – controlling company financing and shareholder returns.

Information

The information clause regulates the company’s duty to give report to the shareholders.

  • Lead investors usually request weekly briefings and extensive monthly management and financial reports.
  • Other shareholders usually have the right for quarterly management and financial reports.

Non-competition

Shareholders that leave the company agree not to compete with a similar business. A non-compete term once exiting a company as a founder can be anywhere between 5 years to life.

This provision you shall look for in a shareholder agreement ensuring your options are once you leave the company.

No-hire provision

A no hire provision regulate that any leaving shareholder will not be allowed to recruit staff from the company.

This is a tricky provision, important to most founders. Even if you add a €1mn penalty, key individuals can be worth more to a competitor. It’s also difficult to regulate against spontaneous applications from employees.

Funding requirement provisions to look for in a shareholder agreement

The funding requirement provision regulates shareholder obligations with regards to the company’s ongoing financing.

A shareholder agreement can prescribe that shareholders shall contribute with security or funding, if so needed. Failing to do so usually triggers a monetary or contractual penalty.

This provision is important to look for in a shareholder agreement, not least for founders and shareholders with limited financial resources.

Insurance provision

It’s good to make an agreement on what insurance the company shall have. Usually this includes liability insurance for the Board of Directors and leading executives. Sometimes a property insurance is listed as well. A standard clause, nothing complicated.

Confidentiality

To no surprise all company’s and their shareholders like to keep things confidential. The confidentiality clause is usually a standard clause.

What you shall look for in a shareholder agreement confidentlality clause are penalties other than symbolic penalties. Extensive obligations in time are also something to be mindful about.

Arbitration

Another standard clause that could get a bit messy if not carefully considered. This is the provision that states how you resolve major disputes with external help. This is like going to court, but in a negotiated business manner.

In some countries there are simplified arbitration process and more extensive arbitration processes. As a founder or small shareholder, you shall argue to include the simplified arbitration process in your shareholder agreement. Your unlikely to afford an extensive legal battle vs. major investors or industrial shareholders in a more extensive arbitration process.

Regardless what has been agreed, there are still circumstances when you may not be able to exercise your rights.

  • You may not afford to buy your portion of shares in a new share issue when the company value grows. The consequence is a diluted shareholding.
  • You may not afford legal counseling if you’re in disagreement in needs to seek arbitration.

Being mindful and seeking advice if the shareholder agreement becomes too complicated is my best advice.

I hope this blog post help you to understand what to look for in a shareholder agreement.

Good luck with your venture!

Read more on how to split equity amongst co-founders in a tech startup.

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