To Draft or Not to Draft: The Shareholder’s Agreement

You have a great business idea, and you’ve decided to partner up with someone to get it started, perhaps a financial partner, someone with particular technical know-how or simply a friend or family member. Whichever case, you will probably have heard the horror stories of people who have lost control of their company, brand, technology, etc. or friendship venture which ended in a fight, and so you may be considering whether you need a Shareholder’s Agreement. Indeed, many will encourage you to create one, but what is it exactly and is it worth it? Keep reading to find out.

What Is It?

A Shareholder’s Agreement sets out the rights and roles of the shareholders of a company. The purpose being to regulate the relationship between the different shareholders and subsequently how a business will be run.

While Shareholder’s Agreements can vary widely depending on the type of company and the jurisdiction in which it was prepared, the main characteristics are to give guidelines in respect of the following:

• ownership and voting rights of the shares in a company;
• how the company will be run;
• how any future disputes between shareholders can be resolved; and
• the protection of the competitive interests of a company.

Is It Worth It?

It depends on your circumstances. First, you should know that when you incorporate your company, you will already have the Articles of Association in place. While this does not cover all the aspects of a Shareholder’s Agreement at a basic level it does help to define the responsibilities of the directors, what kind of business can be performed, and how much control the shareholders have over the directors. But many will argue this is not enough as there is no provision for possible disputes between shareholders which the Shareholder’s Agreement covers. So, how do you decide if it is worth it or not? Let’s weigh up the pros and cons.

PROS

• It Can Act as a “Safety Net.”

At the very least you will have a written document that you can refer to in the event of disputes without having to go to court.

• Not Publicly Accessible

The Articles of Association and other constitutional documents of a company are publicly accessible, while you can create a shareholder’s agreement in private and keep the terms thereof between the entering parties.

• Protection for Minority Shareholders

Minority shareholders can gain a greater level of protection and/or a greater level of power where the local corporate law may not cover them.

• Easier Company Management

You can elaborate rules that make the management of the company easier for funders for instance.

CONS

• Inconsistencies = Less Effective

If the agreement is inconsistent with the Articles of Association and other documents of the company, it could weaken the intended arrangement.

• It Costs Money

It costs money, and it will cost a lot for a decent one. A comprehensive Shareholder’s Agreement drafted by a good law firm can easily set you back thousands of dollars or should you manage to find a very cheap solution you could question the actual efficiency of the final document. Particularly at the beginning stages of setting up, considering you have no guarantee of the business’ success this is a lot to spend on something, not to mention you may never even use it if the company for whatever reason does not succeed.

• It’s Part of The Deal

If you are approaching investors with a Shareholder’s Agreement, it may make your proposal unattractive and lead to disagreements before you even start and perhaps even the interest they may have in your venture. Plus, if you consider to raise funds among institutional investors, most Investment Funds will have their own form of Shareholder’s Agreement that they will present to you on a take it or leave it basis.

• It’s a Never Ending Story

Once you start drafting a Shareholder’s Agreement, you or your partner(s) will always find more things to add to it so as to anticipate any situation that may arise which will, in turn, increase the drafting price. But finally, no matter how much you or your partner(s) add to it you will not be able to cover every risk, and you may not anticipate the issues that you will actually face.

The Verdict?

It would be very politically incorrect to say that a Shareholder’s Agreement is useless, when in fact, it is useful, but at the end of the day whether you need one or not depends on the stakes. If you have a lot of funding and the stakes are high or if you are dealing with big money, then you probably should and will likely have the need and the means to get a Shareholder’s Agreement drafted.

In most cases, however, particularly for new entrepreneurs who we come into contact with daily and sometimes negotiate with us over a few hundred dollars, a Shareholder’s Agreement is simply not affordable especially considering there is no absolute guarantee whether the business will be successful or not. Should you have one, ideally yes, but if you can’t have one done this is not a reason to stop proceeding with your business.

After all, entrepreneurship is all about taking risks. The primary purpose of a Shareholder’s Agreement is to cover some of that risk, but if you try to cover every risk, there is, your business will run after profitability because your margin won’t likely cover the cost of covering every single risk. As the saying goes don’t put the cart before the horse. Although you might plan to have 100 employees in the future, when starting out you wouldn’t sign a lease for a space that could fit 100 employees right?

The day you have a positive sign that your business is successful, and you have more visibility on your actual and potential income, make the move, invest in a Shareholders Agreement!

Alternative Options to a Shareholder’s Agreement

Still feel like you want to have a written document in place. Why not DIY an agreement for shareholders? While it may not be as precise as a document established by a law firm at least, you will have a base for agreeing on rules that everyone can sign.

Or have you decided to proceed with incorporation? iNCUBEE can help just click the button below.

Or feel free to contact us. The iNCUBEE Team will be pleased to answer you.