Starting a company with your business partners is an exhilarating process. You and your business partners have a big vision and a goal to achieve by setting up a company with a strong belief that the company could grow successfully. Everything is well-prepared, from the capitals to the products or services and the operating procedures. But wait, have you considered a shareholders’ agreement?
Shareholders’ agreement is a private contract subscribed voluntarily between all shareholders of a company to regulate their relationships, rights and obligations as well as the daily operations of the company.
You might think that since you are starting a business with close friends or families, there is no need for a formal agreement. You may also think that rather than spending your limited capital on preparing a proper agreement, you would rather prefer to spend it on your business operation and expansion. Well, you are not wrong in thinking that. However, the reality is that, many people do not appreciate the importance of having a properly drafted shareholders’ agreement until a conflict or a problem happens.
In this article, we will illustrate the importance of a shareholders’ agreement and why you should consider signing it at the very beginning of your startup.
Why do you need a shareholders’ agreement?
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It provides a framework for the transparent ownership and management of your company
The essence of a shareholders’ agreement is to set the rules for the shareholders in the company. It sets out the responsibilities and rights of the shareholders and how they want the company to be managed. There is clarity and certainty on what can or cannot be done. As a result, it minimizes the potential conflicts arising out of a disagreement between the shareholders.
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It provides business stability
A startup path is much like a roller coaster. The future is unknown. During the first two or three years of the company, many changes may occur due to various reasons. In this uncertain period, a shareholders’ agreement provides some certainty to the shareholders. It also shows that you have thought through proper planning so that any dispute will be easily and swiftly dealt with. This is important in particular for banks and other potential investors who are looking to invest in your company.
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It outlines how potential disputes between shareholders can be settled
At the start of a new business relationship, it is difficult to foresee a scenario in which the business partners would fall out or have difficulty in making decisions. Unfortunately, disagreements do happen sometimes. It is easier to formalize and document the approach that should be taken if the relationship turns sour at the outset of the relationship.
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Exit gracefully
It may be unnatural or uncomfortable to talk about the exit of the current shareholders. However, an open discussion helps to resolve the disagreements that may arise when a shareholder wants to exit in the future. Shareholders’ agreements can include provisions on how the relationship between shareholders may come to an end and how and when shares can be transferred or bought out by the other shareholders, who wish to remain in the company.
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Protection for all shareholders
Usually, there will be a difference in the shareholding structure, a mixture of majority shareholders and minority shareholders. Different types of shareholders have different concerns and expectations.
The majority shareholders will want to retain control on the matters affecting the company. They usually do not want the minority shareholders to block and hinder the company’s operation. On the other hand, the minority shareholders will want to be heard and be included in the matter involving the company or affecting their interests, benefits and rights. They are worried about being excluded and being deprived of their rights by the majority shareholders. Hence, when it comes to drafting a shareholders’ agreement, it always boils down to a balancing work to ensure each shareholder’s expectations are being taken care of. Regardless of the type of shareholder you are, your interest can be protected by a carefully drafted shareholders’ agreement.
Why should you sign the agreement at the beginning stage of a startup?
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Easy to negotiate
The beginning stage is the most enthusiastic period for the shareholders and everyone is ready to commit. It is easier to reach a consensus when everyone is in a good relationship. Negotiating an agreement encourages the shareholders to address difficult issues that they may neglect or overlook due to their excitement.
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A sense of responsibilities
It instills a sense of responsibility and commitment. When shareholders clearly understand their role and responsibilities through ink and paper, they will be more obliged to adhere to their written promise. As any breach of their obligations may lead them to the bigger trouble of being sued. Besides that, when they know their rights are protected, they are more willing to commit to grow the company.
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Time and energy factor
As the company grows, the shareholders will get busier by the day, and they may even forget about doing an agreement at all. If a dispute arises and there is no shareholders’ agreement in place, huge amount of time and money will be wasted just to settle the disputes. Furthermore, as time goes by, problems such as eroding bargaining position may occur. The initial shareholders who put in sweat and tears to build up the company may find themselves losing control of the business when new shares have been issued and sold to a third party. Or worse, where there is no shareholders’ agreement, every shareholder, whether majority or minority, will seem to want to have a bigger say over the control of the company and when they cannot come to an amicable solution, the only way out is to dissolve the company, thereby throwing all the past efforts into the drain.
Conclusion:
It is true that nobody ever anticipates that a problem would arise. However, if it does, the last thing you want to be doing with family and friends is lawyering up and arguing on what you ‘thought’ the terms of their investment were. Thus, a shareholders’ agreement serves as an effective guidance mechanism on what to do when conflict arises. It saves everyone’s time in debating, arguing, and litigating. Not only that, it may save the relationship between you and your fellow shareholders.
So now that you have learnt why it is important to have a shareholders’ agreement, make sure the next time you build a new venture with your business partners, get that on to your To Do List!
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About the author:
This article was written by Edwin Lee Yong Cieh, Partner and Wong Shen Ming, Trainee Lawyer – a law firm in Kuala Lumpur, Malaysia.
The view expressed in this article is intended to provide a general guide to the subject matter and does not constitute professional legal advice. You are advised to seek proper legal advice for your specific situation.
Edwin is a corporate and technology lawyer. He is also the founder and deputy managing partner of Lee & Poh Partnership (LPP Law). Edwin has advised a range of companies from technology startups to multinational corporations on a range of matters. In 2020, Edwin was named as a Malaysian Rising Star by Asian Legal Business, a finalist for the Young Lawyer of the Year at the ALB Malaysia Law Awards as well as a lawyer in the annual ALB publication of Asia 40 under 40.
View his full profile here.
