Shareholder’s Agreement is an important starting point for many startups and SMEs
Many people decide to go into business at some point in their lives. The number of startups continue to burgeon the world over. Small and medium enterprises (SMEs) make up 99% of all Singapore’s enterprises and account for about half of Singapore’s GDP.
Nearly all of these businesses need a good Shareholder’s Agreement to get started.
No one starts a business expecting things to go wrong
Business partners and shareholders do not plan or assume things will go wrong when they start or invest in a business. Many times, business partners know each other well, and may even be friends or family members. Many might think that a shareholder’s agreement is not important, or that it represents an unnecessary cost to a nascent, cash-strapped business. This is a dangerous way to think.
What is a Shareholder’s Agreement?
A Shareholder’s Agreement is a contract signed by the shareholders in a company. It describes how the company should be run, and the various rights and obligations of each of the shareholders. It can be between some or all the shareholders in the company. It is an essential document that protects minority shareholders in the company.
In a nutshell, a Shareholder’s Agreement covers the following (not exhaustive):
- How a company should be run
- Describe how important decisions will be made
- A shareholder’s rights and obligations
- The rules and regulations around the issuance and transfer of shares in the company (e.g. right of first refusal, valuation method, etc)
- Protection for any minority shareholders in the company by way of a reserved matters list
- Confidentiality and non-compete clauses for founders and management
- What happens when a shareholder passes away
- Deadlock and dispute resolution mechanisms
When will you need a Shareholder’s Agreement?
You typically will want to draft a Shareholder’s Agreement when you form the company and issue shares. This is often a very important exercise since it will help all the involved parties align and be on the same page when everyone starts discussing what goes into the Shareholder’s Agreement, and in what form.
When will you NOT need a Shareholder’s Agreement?
You will not need a Shareholder’s Agreement if there is only one shareholder, say yourself. For example, sole proprietors may not need to draft a shareholder’s agreement. Neither will freelancers or contractors need a shareholder’s agreement.
Don’t delay or defer getting a Shareholder’s Agreement
It is understandable that every business owner (management, who are likely also shareholders) gets caught up in building the business –finding and securing customers, building product, building teams, managing PR and marketing and a whole host of other activities. You might be tempted to put off drafting a Shareholder’s Agreement until you get to the point you get more traction, but you really shouldn’t if you are serious about your business.
It isn’t recommended to delay this discussion, or drafting a Shareholder’s Agreement. Expectations may start to change as the business progresses and if a Shareholder’s Agreement is not locked down early, it can lead to lots of complications amongst the shareholders early in the business when these distractions are absolutely not needed.
What makes a good Shareholder’s Agreement?
A good Shareholder’s Agreement isn’t necessarily one that is very lengthy, or that is very favorable to one party. A good Shareholder’s Agreement is one that provides solutions and mechanisms to resolve certain scenarios and disputes, such as how shares should be transferred, namely whether existing shareholders have a right of first refusal and what happens when there is a deadlock in the management of the company.
Drafting a good Shareholder’s Agreement is important for several reasons:
- The discussion while drafting it can help align shareholders and management in the company
- Reduce ambiguity when things don’t go according to plan (which typically happens)
The idea is to make the Shareholder’s Agreement a guiding beacon for the main actors in a company rather than something that you expect to take to court in a nasty and acrimonious battle down the road.
Tips on drafting a Shareholder’s Agreement
Here are a few tips to watch out for when you work with your lawyer in drafting a good Shareholder’s Agreement between you and your partners. It isn’t meant to be a comprehensive guide on what to include in your Shareholder’s Agreement (you may read about that in a separate article here) but overarching tips to keep in mind when you are drafting your Shareholder’s Agreement.
- Be specific, not vague
You might be tempted to word your Shareholder’s Agreement in a less-than-precise way so that it leaves some parties with some flexibility to interpret the contract, but this would defeat the purpose of the agreement. This can create a lot more dissent and ambiguity if any disputes should come up, and devolve into a he-said, she-said, we-assumed discussion which isn’t productive. Be clear, precise, specific and direct when you word your Shareholder’s Agreement.
- Plan for difficult scenarios
You can think of a part of drafting your Shareholder’s Agreement as thinking up all the various ways things can go wrong in your company, planning potential solutions around these problems and putting them into your contract. What if someone falls ill or has other priorities and has to leave the company? What if the company needs more funding? What if there are disagreements (see later tip on dispute resolution)?
- Dispute resolution procedures
Be sure to describe how disputes will be resolved and settled (e.g. arbitration, mediation, etc). While you typically don’t want disputes to happen, they do occur, and more frequently than you think. You may also want to include mechanisms for exit due to a dispute – how can an existing shareholder exit this arrangement, and at what valuation? You can read more about the 10 most common causes of disputes in small and medium businesses here, or the ways you can resolve them here.
- Get a lawyer to help you draft or vet your Shareholder’s Agreement – While you technically do not need a lawyer to draft a Shareholder’s Agreement, it is highly recommended that you hire one to help you at least review your Shareholder’s Agreement. This is because this will be such an important document to the business. You do not want to be downloading paid or free templates and trying to customise it yourself without some insurance or assurance from a professional who has helped many other businesses (in your exact business sector) draft their Shareholder’s Agreements.
Frequently asked questions
Question 1: Must my company be party to the Shareholder’s Agreement?
No, it is not mandatory, however, there are certain advantages and disadvantages if the company is party to the Shareholder’s Agreement. There is the advantage of making enforcement of the agreement’s terms easier if the company is included in a Shareholder’s Agreement so that the company is bound by the obligations in the agreement. A claimant will also find it helpful to be able to sue the company (which may have deeper pockets) as well as the other shareholders if necessary.
If the Company itself joins in as a party, it is vital that any restrictions it undertakes do not fetter its powers under the Companies Act in Singapore.
Question 2: Is a Shareholder’s Agreement different from the Company’s constitution?
Yes, the constitution of a company is a legal document that sets out how the company is to be internally governed by the rules and regulations found therein. For example, it covers matters such as the quorum required for the conduct of a board or shareholders’ meeting, the appointment of directors and the powers of directors amongst others. On the other hand, a Shareholder’s Agreement covers other matters that sets out the understanding between the partners. For example, whether the partners can compete in the same line of business as the company and what happens when there is a deadlock amongst them. Whilst there is definitely some overlap between the two documents, there are some differences but both are equally important. Lastly, the constitution is a public document that can be purchased online whilst a Shareholder’s Agreement is a private agreement that is confidential.
Have a question on drafting a Shareholder’s Agreement?
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This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to a practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.