Shareholders Agreements: Seven Key Points Startups and Scaleups Should Consider

A Shareholders Agreement is crucial for most startups and scaleups, as well as many other companies. Here are seven key things startups and scaleups should consider when are thinking of putting a Shareholders Agreement in place:

  1. What stage is your company at?
    If your company has only one shareholder then you may be jumping the gun by putting a Shareholders Agreement in place. However, if you are about to apply for a grant or you are looking for (or have) potential seed or series A investors, a Shareholders Agreement may be warranted, or may even be required, as a term of the grant, or by your potential investors. If you are a startup with two or more founder shareholders, having us draft a Shareholders Agreement for you is a really good idea. Not only will potential investors require one, but a Shareholders Agreement can set out what happens if you get into a deadlock with your co-founder. The last thing you want to be doing is running off to court to settle disputes that can be resolved in a much more expedient and cost-effective manner. If your company is at the scale-up stage with incoming investors looking to invest in preference shares, then a Shareholders Agreement is a must. Investors want clarity on the ownership structure and the allocation of equity among shareholders to understand their proportional stake in the company.
  2. Ownership and Shareholder Rights
    As your company progresses through different stages of growth, it becomes paramount that your Shareholders Agreement adequately addresses ownership and shareholder rights. By doing so, you create a solid framework that establishes the rules and principles governing how ownership is structured and how shareholders’ rights are safeguarded. Alongside ownership, determining the corresponding voting power each shareholder possesses is of significant importance. Voting rights grant shareholders, the ability to influence crucial company decisions, elect board members, and voice their opinions on key matters. By specifying voting power, you establish a fair and democratic approach to governance, where shareholders’ voices are appropriately represented based on their ownership proportions. Furthermore, as your company evolves, it may attract investors or involve different classes of shares, each with unique characteristics. In such scenarios, identifying any special rights or privileges that certain shareholders may have becomes essential. These special rights can include but are not limited to, preferential dividend rights, veto powers on specific decisions, or priority in liquidation proceeds. Clearly outlining these rights in the shareholders’ agreement ensures a transparent understanding among all parties involved and mitigates potential conflicts that may arise in the future.
  3. Roles and Responsibilities
    To foster smooth management and decision-making processes, your Shareholders Agreement must outline the roles and responsibilities of each shareholder involved in your startup or scaleup. Your Shareholders Agreement should set out the various rights and obligations of each party, including board representation, appointment of key executives, and approval thresholds for significant matters. You will also need to determine what is a ‘significant matter’ that requires special shareholder approval – these are generally decisions that require an affirmative shareholder vote of 75% or more and typically have to do with decisions that fundamentally affect the company or the business such as the creation of preference shares, restructures, and capital expenditures over an agreed threshold.Clearly defining roles and responsibilities becomes particularly important when dealing with active and passive investors, co-founders, or external stakeholders. Certain investors may want a position on the board, or the right to appoint board observers. If you are a founder, you will likely want to ensure that the relevant provisions grant you the right to remain on the board and that your voice will still be heard even as your company grows.
  4. Pre-emptive Rights
    Pre-emptive rights, or “rights of first refusal,” are essential if you want to manage share transfers among shareholders and preserve your company’s ownership structure. These rights give existing shareholders the priority to purchase any shares being sold by a shareholder who wishes to transfer their ownership to an external party.By including pre-emptive rights in your shareholders’ agreement, you empower current shareholders with the ability to safeguard their proportional stakes in the company. When a shareholder intends to sell their shares, they must first offer them to existing shareholders. This process allows shareholders to maintain control over who becomes a new owner and prevents undesirable third-party involvement that could impact the company’s direction or decision-making.
  5. Dividends
    When dealing with preference shares and investors, provisions governing dividends are crucial to address how profits will be distributed among shareholders. In this regard, transparency and clarity are key and go a long way to prevent possible disputes. For that reason, it is essential that your Shareholders Agreement clearly sets out if dividends will be proportional to ownership stakes or if alternative dividend mechanisms will be included to ensure all parties are aware of their respective entitlements.Dividends distributed proportionally can offer a fair share of returns to each shareholder based on their ownership percentage. On the other hand, alternative mechanisms may involve different criteria, such as the level of investment, class of shares held, or other performance-based metrics.

    How your Shareholders Agreement handles dividends can significantly influence how attractive the company is to potential investors. For instance, if the company reinvests profits to fuel growth and innovation, it may be appealing to investors seeking long-term capital appreciation. Conversely, regular dividend payouts could attract income-focused investors seeking immediate returns on their investments.

  6. Dispute Resolution

    Disputes among shareholders are not uncommon in the life of a company, and it’s essential to have well-defined dispute resolution mechanisms in your Shareholders Agreement to address such situations promptly and efficiently. By having clear procedures in place, potential conflicts can be resolved in a fair and structured manner, minimising disruptions to the business and preserving shareholder relationships.

    Common dispute resolution mechanisms that may be included in Shareholders Agreement are buy-out provisions, a requirement to refer disputes to mediation or arbitration, or to refer a dispute for expert determination (this can be useful if the dispute involves complex or technical issues). Shotgun deadlock provisions are somewhat less common but are very useful to include where there are only two founder shareholders. In such companies, shotgun deadlock provisions prevent prolonged stalemates that can harm the company’s operations and are used to break impasses by incorporating methods to rapidly resolve disputes without engaging in litigation.

  7. Exit Strategies
    Exit strategies are the procedures and mechanisms governing when shareholders can exit the company in various circumstances. What your exit strategy will look like should reflect your vision of where you want to be in say 5 or 10 years. For example, your Shareholders Agreement may specify how your company will be valued during an exit, ensuring a fair and transparent process. Other common exit strategies include buyback options, drag-along and tag-along rights.Buyback options allow the company or other shareholders to purchase shares from a departing shareholder. Drag-along rights empower majority shareholders to compel minority shareholders to join in the sale of the company. Tag-along rights, on the other hand, protect minority shareholders, allowing them to sell their shares alongside majority shareholders during an exit event.

    We always advise startups and scale-ups to identify their exit strategy from the beginning. By having a Shareholders Agreement that incorporates comprehensive exit strategies, shareholders can have confidence in the long-term sustainability and scalability of the company, in full knowledge that potential exit scenarios have been carefully considered.

Adventum Legal specialises in drafting shareholders for companies, regardless of their size. Whether you are a founder or investing shareholder located in Australia or abroad we would love to chat with you about how we can help protect your interests – why not contact us?

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