The Importance of Shareholder Agreements for Small Businesses

What is a shareholder agreement?

In the most straightforward terms, a shareholder agreement is a legal document that outlines how a company will be run and the rights and responsibilities of the shareholders. Think of it as the rulebook for the game of your business providing rules for how the shareholders can sell their shares, what happens if a shareholder leaves the company, how decisions will be made, and so on. There will always be differences in opinion amongst shareholders, for example, around company direction, shareholders leaving the company, or selling their shares, which can lead to costly and time-consuming legal battles. Without a shareholder agreement in place, the potential for disputes is significantly increased.

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Let’s look at an example.

TechNex was a startup founded by three friends who were passionate about technology. They launched the company with a 50-30-20 share split. Initially, the common goal was clear: to create innovative tech solutions. However, as the company grew, each of the founders’ visions changed with only one founder wanting to continue with their current services. As they didn’t have a shareholder agreement in place defining how such disputes should be resolved, the situation turned into a deadlock. There was no agreement on what mechanism to use to break the deadlock, so the matter ended up in court with massive legal bills.

This put a financial strain on TechNex, preventing its growth and damaging its reputation. It also led to a delay in decision-making, putting them behind their competitors. Then the majority shareholder decided to sell her shares to an external investor, a scenario that the remaining two founders were not prepared for. As there was no shareholder agreement, they had no first refusal right, meaning they couldn't purchase the shares before they were offered to external parties. The new shareholder had a different vision for the company which created even more conflict.

If TechNex had a shareholder agreement from the start they could have avoided most of these complications. The agreement could have outlined a decision-making process, mechanisms to handle conflicts, and provisions regarding the transfer of shares. So, by ensuring all shareholders are on the same page, a shareholder agreement really can reduce the risk of disagreements escalating into full-blown legal disputes.

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When do you need to have a shareholder agreement?

There is no specific law or rule that says a company must have a shareholders’ agreement, although - as you can see from this article - we strongly recommend that your business puts this in place. You can get a shareholder agreement at any time but generally, it is advisable to get this when you start your company or when the company has more than one shareholder, or even when a new shareholder gets shares.

Read further on key provisions to look out for!

Don't have a shareholders agreement in place? Take a look at ours.?