A shareholders' agreement is more than just a legal formality — it's a foundational document that defines the relationship between shareholders and sets the ground rules for how a company operates.
Without a well-structured agreement that follows a specific format, businesses can face disputes, management issues, and unforeseen complications.
In this article, we’ll explore nine essential components that every shareholders' agreement should include to ensure it effectively protects the interests of all parties involved and supports the company's long-term success.
1. Capital Contributions & Financing
Outlining initial contributions and future funding obligations ensures that the company is adequately financed and that all shareholders are clear on their financial commitments.
Check to see if your shareholder agreement format includes both initial contributions and future funding. Initial contributions will include details on the amount and nature (cash, assets, etc.) of contributions each shareholder is expected to make. The future funding stipulations section can address mechanisms for raising additional capital, including obligations of shareholders to contribute.
2. Dividend Policy
A defined dividend policy balances the need for profit distribution with reinvestment, ensuring that shareholders' expectations for returns are aligned with the company's growth objectives. In this part of the shareholders’ agreement template, ensure profit distribution is outlined, including how and when profits will be distributed to shareholders.
Not only should this section focus on the profit but it should also define rules for reinvesting profits back into the business.
3. Responsibilities of Participating Shareholders
Clearly defining roles and voting rights ensures that all shareholders understand their influence on decision-making, preventing potential power struggles.
The first thing that needs to be outlined is roles and involvement in the agreement. This clarifies the roles of shareholders, especially if some are also directors or employees. Additionally, establishing the management structure and decision-making processes avoids confusion and ensures that critical business decisions are made with appropriate oversight.
Here are some considerations:
- Board Composition: Guidelines for appointing and removing directors, including their powers and duties.
- Reserved Matters: Specific decisions that require shareholder approval, such as mergers, acquisitions, or significant borrowing.
- Deadlock Provisions: How to resolve disputes or deadlocks between shareholders.
- Voting rights: These include sharing how decisions will be made, including which matters require unanimous or majority approval.
4. Confidentiality & Non-Compete Clauses
Protecting sensitive information and preventing competition safeguards the company's interests and maintains its competitive advantage.
When reviewing your shareholders’ agreement, ensure there are specific examples of how confidential information is being handled — outlining safeguards for protecting business secrets and sensitive information.
Non-complete agreement terms are important to include in this section as well, detailing restrictions that prevent shareholders from engaging in competing businesses.
5. Dispute Resolution
Setting out mechanisms for dispute resolution helps avoid costly and time-consuming litigation, providing a clear path for resolving conflicts. The agreement should address mediation and arbitration, including methods for resolving disputes outside of court and which jurisdiction’s laws apply to the agreement.
6. Share Transfer Restrictions
Restrictions like pre-emption rights protect existing shareholders by controlling who can buy shares, maintaining the company's stability and preventing unwanted external influence.
Within the shareholders’ agreement format, detail both pre-emption rights as well as drag-along and tag-along rights. Pre-emption rights give existing shareholders the first right to buy shares before they are offered to outsiders. Drag-along and tag-along rights protect minority shareholders and ensure they get fair treatment in case of a sale.
7. Exit Provisions & Triggering Events
Clear exit provisions provide a roadmap for what happens when a shareholder leaves, ensuring a fair process and continuity for the company. Does the shareholders’ agreement include rules for exiting the company? Here, trigger events and conditions under which shareholders must sell their shares (e.g., death, bankruptcy), will be detailed. Additionally, it’s important to cover how shares will be valued in case of an exit.
Look for an exit strategy that outlines buy-sell agreements and valuation methods and ensure the exit strategy is airtight with these tips.
8. Amendment Process
Defining how the agreement can be amended ensures that any changes reflect the consensus of a significant majority, maintaining stability and fairness.
9. Termination Clause
Including a termination clause outlines how and when the agreement can be terminated. This provides clarity on how the relationship between shareholders can be formally concluded.
Ensure Your Shareholders’ Agreement Supports Your Company’s Long-Term Success
Including these elements helps to prevent disputes, ensures clarity in operations, and provides a clear framework for managing the relationship between shareholders.
We discuss items in a shareholders’ agreement template and more in our webinar — Shareholders' Agreements: the Good, the Bad, and the Ugly. Learn more about:
- Shareholder agreement risks and critical elements to include
- Considerations from a tax perspective
- What works and does not work in relation to shareholder agreements
To discuss this topic in further detail, please contact Brian Kitchen, Director, Tax Strategies or Thomas Yankanich, Director, Audit & Accounting.