Shares Agreement Contract Essentials for Shareholders

Key Takeaways

• A shares agreement contract outlines shareholder rights, responsibilities, and share ownership protocols.
• These contracts often include provisions for dispute resolution, dividend policy, confidentiality, and exit strategies.
• A well-crafted agreement helps prevent future conflicts by setting clear rules and expectations.
• Clauses like drag-along/tag-along rights, valuation mechanisms, and decision-making thresholds are essential.
• Legal enforcement and updates to the agreement should align with corporate bylaws and applicable laws.

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.

Important Parts of Legal Agreements

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.

Additional Key Clauses in a Shares Agreement Contract

Beyond the foundational elements, several advanced provisions can significantly strengthen a shares agreement contract:

• Dividend Policy: Specifies how and when dividends will be distributed. This ensures transparency and prevents disputes about reinvestment vs. payout.
• Valuation Mechanisms: Defines how shares will be valued if a shareholder exits the company. Common methods include fixed pricing, independent valuation, or formula-based approaches.
• Deadlock Resolution: Outlines procedures for resolving impasses in decision-making, especially in 50/50 ownership scenarios. Mechanisms may include buy-sell clauses, mediation, or arbitration.
• Confidentiality and Non-Compete Clauses: Prevent shareholders from disclosing sensitive information or starting rival businesses.
• Tag-Along and Drag-Along Rights:
  • Tag-along rights allow minority shareholders to join in a sale if a majority shareholder sells their stake.
  • Drag-along rights allow majority shareholders to compel minority holders to sell during a company acquisition, ensuring smoother transactions.
• Right of First Refusal (ROFR): Grants existing shareholders the opportunity to purchase shares before they’re offered to outside buyers.
• Exit Strategies: Addresses scenarios like IPOs, buyouts, or mergers, and defines shareholder roles and options in such events.

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.

When Is a Shares Agreement Contract Legally Enforceable?

A shares agreement contract is legally enforceable when it complies with the applicable corporate laws and doesn’t conflict with the company's articles of incorporation or bylaws. To ensure enforceability:

• The agreement must be signed by all parties involved.
• Its terms must be clear, fair, and not contrary to public policy.
• Courts may scrutinize provisions related to minority shareholder rights, especially if they affect equity or access to information.

Even though it is a private document, a properly executed shareholder agreement holds legal weight and can be used in court to resolve disputes.

Updating and Reviewing Your Shares Agreement Contract

As businesses grow and evolve, shareholder expectations and ownership dynamics can shift. A shares agreement contract should be reviewed:

• Upon issuance of new shares or onboarding of new shareholders.
• During major financing rounds or structural changes.
• Periodically, to ensure compliance with updated laws and market practices.

Failure to update the agreement may lead to outdated terms that could cause governance issues or conflict among shareholders.

Frequently Asked Questions

1. What is the main purpose of a shares agreement contract?
   It outlines the rights, responsibilities, and protections of shareholders to ensure orderly governance and minimize future disputes.
2. Can a shares agreement contract override corporate bylaws?
   No, it must align with corporate bylaws and the company's articles of incorporation. Conflicts may invalidate certain provisions.
3. Is a shareholder agreement mandatory?
   While not legally required, it is highly recommended, especially for private companies with multiple stakeholders.
4. How are shares valued in a shareholder exit?
   Valuation methods are typically defined in the agreement and can include fixed prices, formulas, or third-party appraisals.
5. When should a shares agreement contract be updated?
   Update it after significant business changes such as new shareholders, major investments, or regulatory changes.

If you need help with a contract for shares of a company, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.