30 NOV 2018

Why Your Startup Needs a Shareholders' Agreement

What is a Shareholders’ Agreement?

A shareholders’ agreement (SHA), is a document that defines the relationship of a company’s members also known as “shareholders” and describes how the company intends to operate. The goal of this legal documentation is to protect the rights and privileges of each shareholder as well as to preserve the intentions of the original members of the company in case of future disputes.

A shareholders’ agreement is similar to a partnership agreement except that it applies to companies limited by shares, where a partnership agreement applies to business partnerships.

Shareholders’ Agreement Usage in Malaysia

So what should a shareholders’ agreement include?

First and foremost, any shareholders’ agreement should outline the general management of handling the shares. The agreement includes the identities of all the members and states the clear goals of the formation of the company, how it is to be operated and managed, the rights and obligations of the shareholders, and the protection and privileges of each of the shareholders.

Importance of a Shareholders’ Agreement for Entrepreneurs

Typically, the main document that governs the company and the relationship between its shareholders is the shareholders’ agreement. A shareholders’ agreement records the understanding of the shareholders, in particular, on how the company is to be operated in accordance to the shareholders’ wishes.

There is another document that governs the internal management of the company called the constitution of the company. As opposed to the constitution of the company which is available publicly, the shareholders’ agreement is a private contract whose details are deemed confidential in nature. Importantly, the terms of the shareholders’ agreement is typically mirrored and implemented in a company vis-a-vis the constitution of the company.

Having a shareholders’ agreement will ensure that that the running of the company and the responsibilities of the shareholders are properly set out, in particular there is clarity and certainty as to what can or cannot be done by the company. As such, it will reduce the potential for issues, conflicts or disputes between shareholders and help the company to run smoothly. In order to assure the legal security of the company, it is important for entrepreneurs to have a shareholders’ agreement. The agreement will not only prevent problems but will regulate how they can be solved.

Entrepreneurs, especially members of a startup company with a small group of shareholders, understand that the company’s future is unwritten. Shareholders’ agreements are more flexible when a company wants to revise the established business arrangements. Members use the shareholders’ agreement to supplement the constitution of the company so they can allow for fluid changes and deal directly with disputes before involving the courts (e.g. arbitration procedures). Since a shareholders’ agreement can be amended by mutual agreement of the signing parties without intrusion from the law or legal fees, this gives the startup room to make it through the growing pains without falling apart.

What Protections Does a Shareholders’ Agreement Confer?

A shareholders’ agreement is also vital in providing safeguards for minority members. In some countries, corporate law does not protect standing within the company from those with more power. In order to combat this, a shareholders’ agreement is an entrepreneurial tool to fortify minority members’ rights in the eyes of the law. This can prevent company takeovers based solely on financial resources, especially if they are not in the interest of the preservation of the company. Protection often includes preferential treatment or “pre-emptive rights” for current minority shareholders who may wish to purchase additional shares to safeguard their ownership if new shares are issued.

Other types of minority protection under shareholders agreement include, among others, reserved matters and tag along rights. The agreement can provide for reserve matters that the shareholders or the company cannot do without first obtaining the affirmative vote of the minority shareholders. As for tag along rights, it gives the minority shareholder the right to insist that his shares can also be sold to a third party to whom the other shareholder proposes to sell his shares, on the same terms and conditions.

A shareholders’ agreement is a piece of legal documentation that every startup should have on the books. It outlines the rights and obligations of each shareholder in the business, protects the little guy, stops disputes before they start, and avoids the hassle of legal fees down the road. Short of contacting legal services, a shareholders’ agreement is a smart way to prepare your fledgling business for change and future growth.

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