1. Important Parts of Legal Agreements
2. What is a Shareholder Agreement?
3. What Should Be Included in a Shareholder Agreement?
4. Why are Shareholder Agreements Important?

A contract for shares of a company, also called a shareholder agreement, includes the terms of a new business for anyone working for the company. It also details whether intellectual property rights will be owned by the founders or investors and how shares will be transferred or sold.

New companies should have fairly simple legal agreements, but they should remember two important figures:

  • 50.1 percent is the vote needed to legally control the board
  • 66.67 percent is the vote needed to make other changes to the corporate structure

In general, founders shouldn't worry about long-term financial issues in their first legal agreements. Instead of focusing on a robust agreement that covers everything under the sun, founders should focus on the company's expected lifespan, which is typically until the next round of financing.

What is a Shareholder Agreement?

A shareholder agreement is an agreement between the shareholders of a corporation. It establishes how the company is organized, how it will operate, and what rights and obligations the shareholders will have. It also states how the shares will be issued.

A shareholder agreement must have reasonable terms and conditions and can't be used to defraud anyone. Although a shareholder agreement should be unique to the needs of the corporation, it should still cover certain key provisions, including:

  • Rights and obligations of the corporation and shareholders
  • If there are restrictions for transferring shares
  • The process and rules for choosing a board of directors and corporate officers

What Should Be Included in a Shareholder Agreement?

There are a few key elements that need to be included in a shareholder agreement in order for it to be understandable and valid. The basics include the following:

  • Requirements to be a shareholder
  • Requirements to sit on the board of directors
  • The process if a shareholder dies, goes bankrupt, retires, or is fired
  • The value of the shares
  • If the company is required to buy the shares from a departing shareholder and the price of those shares.

The agreement can also include clauses to cover the following issues:

  • Election of the board. The agreement should include what types of shareholders have the right to elect corporate directors. Including this in the document helps ensure that important founders are properly represented on the board of directors.
  • Special shareholder approvals. The agreement can allow certain groups of shareholders approval over specific corporate changes. This can include things like creating a new class of shares or approving to sell the company.
  • Restrictions of share transfers. Most shareholder agreements limit the transfer of shares unless it is a circumstance that is stated beforehand. This is done to prevent the company's shares from ending up belonging to the wrong investors.
  • Pre-emptive rights. In many circumstances, shareholders allow investors a chance to get their proportional share of any new products or shares of the company, called pre-emptive rights. This typically occurs in seed financing and venture-backed transactions.
  • Drag-along rights. Also typical in most venture-backed transactions are drag-along rights, which require minority shareholders to sell their shares or vote in support of an acquisition.
  • Reverse vesting provisions. Some founders want their co-founders to have to reach certain milestones or accomplishments in the company in order to earn more shares. If this is the case, there should be a clause in the shareholder agreement that gives the company the right to re-buy the shares that co-founders don't earn. The company or other shareholders are usually allowed to buy these shares at little or no cost.

Why are Shareholder Agreements Important?

A shareholder agreement is valuable because it helps spell out what the founders of the company originally wanted. This clarification can help minimize any future disputes. Creating an actual document also causes the founders and shareholders to think through many possible scenarios and have a plan in place before they occur.

Business partners often start out on good terms but then fall out later. Although this can't be anticipated, a well-written shareholder agreement can help prevent major damage or legal action from occurring if there is a disagreement. The shareholder agreement details what both sides agreed to before the disagreement, which can prevent one founder or shareholder from doing something drastic to how the business is run.

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