SHAREHOLDERS’ AGREEMENTS: WHY YOU NEED ONE FOR YOUR STARTUP

Starting a business is every entrepreneur’s dream but starting right is what differentiates successful entrepreneurs from the rest. A business build on strong foundations has a better chance of surviving past the first year of business. In the recent post, we looked at the legal structures entrepreneurs may use to set up their businesses. One of the common structures is a limited liability company which is easy to set up. It can be set up with one founder or with several founders. Having several members in a limited liability company makes it easy to attract investors and raise capital from outside sources. Like any marriage, a fellowship of several founders is bound to have its challenges. This makes it imperative to have proper regulations such as shareholders’ agreements that govern the relationship between the founders.

Recently, a friend called me for an urgent consultation meeting, to which I obliged. I sat down with Peter who expressed his frustrations with his fellow shareholder and director in his business. His frustrations coming from the fact that he has been side-lined by his co-founder to the extent of denying him access to the company’s financial records and bank accounts. Allan was seeking advice on how to ‘get back’ in to the business or alternatively exit and cash in on his investments. A week later, another friend also called with a similar problem and wanted to know his way out of a business relationship that had turned out toxic. In both cases, none of my friends had a shareholders’ agreement in their companies therefore making it harder to find an exit mechanism.

What is a Shareholders’ Agreement

Many entrepreneurs are faced with such challenges and these are not limited to disputes among shareholders. It is therefore important for any company that has two or more shareholders to have a shareholders’ agreement in place from the onset. A shareholders’ agreement is an agreement that creates a contractual relationship between the shareholders of private limited company. It enables individual shareholders to enforce their rights under the agreement against each other in addition to enforcing their rights under the company’s constitution or the articles of association.

Importance of a Shareholders’ Agreement

A shareholders’ agreement is important because it can be used to predict certain elements that can affect the company’s growth in the future. The agreement will not only prevent problems but will regulate how they can be solved. A shareholders’ agreement has several advantages. Firstly, it provides a mechanism for managing a company. The agreement will lay down the procedure for appointing directors and members of the board. Secondly, a comprehensive shareholders’ agreement will protect minority shareholders and ensure their interests are well represented in the board of directors. Another advantage of having a shareholders’ agreement is that it lays down the procedure of solving disputes among shareholders. This saves the shareholders and the company a lot of valuable time and resources that go into dispute resolution. Thirdly, a shareholders’ agreement provides for a mechanism of valuing the company shares. This is important when there is a potential acquisition or merger of the company or in instances where a shareholder wants to sell his shares to the remaining shareholders.

Majority and Minority Protection

The protection of minority shareholders is important and can only be achieved by entrenching their rights in a shareholders’ agreement. Minority protections like ‘tag along’ clauses should be incorporated in a shareholders’ agreement in companies with a significant proportion of minority shareholders. Majority shareholders can also have certain protections like ‘drag long’ rights which protect them from uncooperative minority shareholders. Other protection provisions like non-compete and confidentiality are also important to protect the company’s business.

It is recommended that entrepreneurs seek professional legal advice regarding shareholders’ agreements. All founders and shareholders need to understand the implications of entering into a shareholders’ agreement to avoid any misunderstanding in the future.

I have written an eBook Shareholders’ Agreements: A Legal Guide For Startup Entrepreneurs’ to give you more information on shareholders’ agreements. I have included in the book a sample shareholders’ agreement to assist entrepreneurs understand more on how to go about negotiating their agreements. The book goes for only $.3.99 and can be pre-ordered the book on Amazon by clicking this link. However and for a very limited time, I am giving away free copies to my blog subscribers. If you are a new reader, kindly subscribe to my newsletter to receive your free copy.

For more information or consultation on shareholders agreements, kindly email me at bryan@bryanyusuf.com. Thanks for reading and feel free to share this post.

By Bryan Yusuf

Bryan is the Managing Partner at Bryan Yusuf & Associates Advocates. He is an experienced corporate commercial lawyer with expertise in general commercial and corporate matters, banking and finance, real estate and intellectual property. Bryan is passionate about startups and small businesses and provides them with consultancy and legal services. If you are looking for legal advice or services for your startup or business, just get in touch. 

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