In the course of carrying out business operations, differences among shareholders are an inevitable feature in a business setting. This is why having a shareholders agreement in place, a binding document that clearly sets out the rules, can be the difference between a thriving company and a broken partnership.
Imagine owning a company with a few trusted partners. At the beginning, everything happens to move smoothly, decisions are mutual, trust is evident, and everyone is focused on growth. But as the business expands, things begin to change. One partner desires to sell their shares to an outsider. Another starts making key decisions without proper consultation with his/her co-founder. The minority shareholder begins to feel sidelined, unsure of their rights or how to protect their investment. At this point, uncertainty replaces trust. Simple disagreements can quickly escalate into serious conflicts.
This is where a shareholders’ agreement becomes not just important, but essential. This article focuses on highlighting important reasons why a shareholder agreement is important, who needs this agreement, and when is the best time to have a shareholder agreement. Founders should consider this especially when they contemplate forming a company.
WHAT IS A SHAREHOLDERS AGREEMENT
A shareholders agreement is a legally binding document that defines how a company operates and clearly outlines the rights and obligations of each shareholder. It ensures fair treatment and protects minority interests. Moreover, it provides clarity on critical matters such as ownership rights, share transfer restrictions, and management responsibilities.[1]
WHY IS SHAREHOLDERS AGREEMENT IMPORTANT
- Settlement of Disputes:
No matter how good a person’s intentions are, issues are bound to arise in the day-to-day running or management of a company’s operations between the company and its shareholders. The settlement of disputes can be time-consuming and very expensive for the company to handle. In this regard, the Shareholders Agreement provides an efficient and cost-effective mechanism for managing future disputes. It does this by establishing a clear framework and procedures for resolving such issues and by specifying how certain decisions should be made.[2] This helps to prevent the adoption of stringent measures by shareholders and ensures that all parties maintain a unified objective of promoting the success and growth of the company.
- Governs the Management of the Company
Generally, the board of directors are in-charge of the day-to-day running of the company, although there is a misinterpretation that it is the shareholders who are always in charge despite having less control in decision-making. But where the shareholders’ agreement is well written, the directors can be held responsible for their actions. The directors will be coerced into seeking the consent of the shareholders before making an important decision for the company.[3]
- Safeguarding the Minority Shareholders:
While the minority shareholders may hold little value, the Shareholders Agreement helps to ensure that before any important decision can be made, the consent of all the minority shareholders must be taken into consideration. As a result, the majority shareholders cannot compel the minority shareholders to do or accept things that are not in their favour.
- Protection for Majority shareholders:
A Shareholders’ Agreement (SHA) may include a drag-along provision. Drag-along provision means that if the majority shareholders decide to sell the company, they can make the minority shareholders sell their shares too. This provision allows the majority shareholders to restrain the minority shareholder from delaying or blocking the sale of the company.
- Prevention and Management of Decision-Making Deadlocks
During the life of a company, disagreements may arise between shareholders and directors on important matters. When they are unable to reach an agreement, this can result in a deadlock, which may disrupt or even bring the company’s operations to a halt.
In this regard, the Shareholders’ Agreement (SHA) helps to manage this risk by including provisions that outline clear procedures for resolving such disputes efficiently. These may include mechanisms that allow one party to buy out the other to break the impasse.
- Control the Transfer of Shares
Where the company’s articles do not include rules on share transfers, shareholders may be able to sell or transfer their shares freely. This could mean selling to someone unknown or even to a competitor. In this regard, the Shareholder Agreement can prevent this by giving the other shareholders a “right of first refusal”. This means that if one shareholder wants to sell their shares, the other shareholders get the first chance to buy them. And if the other shareholders do not buy the shares, the Shareholder Agreement can require the new shareholder to sign a “Deed of Adherence”. This makes them follow all the rules of the existing SHA. This protects all shareholders by ensuring that any new shareholder must act according to the agreed terms. Thus, the agreement keeps the company stable and secure.
WHO NEEDS A SHAREHOLDER AGREEMENT?
A shareholder agreement is essential for companies with two or more shareholders, particularly for startups, family businesses, or companies with external investors. It is used to define rights, restrict share transfers, manage conflicts, and outline exit strategies. As a result, it ensures company stability.[4]
WHEN IS THE BEST TIME TO HAVE A SHAREHOLDER’S AGREEMENT
The best time to have a shareholders’ agreement is before or immediately upon incorporating the company, especially when the founders are still on good terms and in the early planning stages.[5] Prompt execution of a shareholders’ agreement is essential. This is because postponement may leave the corporation vulnerable to disputes and potentially expensive litigation.
Conclusion
Recognising the need for and implementing Shareholders’ Agreements enhances corporate governance, facilitates the smooth operation of the company, and increases the likelihood of successful fundraising. Once established, directors must understand these agreements thoroughly to safeguard shareholder interests and ensure effective governance. They must also prevent disputes. By adhering to best practices and maintaining clear communication, directors can manage Shareholders’ Agreements efficiently. This approach contributes to the company’s long-term success.
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[1] https://haysmac.com/insights/understanding-shareholder-agreements-what-directors-need-to-know/#:~:text=It%20may%20outline%20the%20roles,that%20their%20interests%20are%20protected.
[2] https://cleaverfultonrankin.co.uk/legal-update/six-reasons-to-have-a-shareholders-agreement/
[3] Ibid
[4] https://muscattblackgraf.com/who-needs-a-shareholders-agreement/
[5] https://www.mondaq.com/nigeria/shareholders/1154382/understanding-startup-agreements-in-nigeria
