What is a Shareholders' Agreement and Why is it Important to Companies and Investors?

It is therefore in the common interest of companies, their founders, their shareholders and their future investors to have a solid and workable shareholders’ agreement in place, and to make sure they understand its provisions. Before becoming an equity investor in a company, it is important to find out if there is a shareholders’ agreement in place, as you will likely be required to sign up to it.

Matters covered in a shareholders’ agreement include guidelines on share ownership, issuance, and transfer, as well as profit and loss distribution, company management, and dispute resolution mechanisms. The agreement may also deal with governance issues, such as the frequency and structure of shareholder meetings, voting rights, and decision-making authority. The specific content of a shareholders' agreement varies based on the unique needs and circumstances of the parties involved and is subject to negotiation.

Typically, shareholders' agreements are not publicly accessible (with some exceptions), which is a significant advantage in terms of confidentiality.

What are the risks for companies and investors of not having a shareholders’ agreement? 

Without clear pre-set rules on important matters such as share sales, profit distribution and decision-making, disagreements among shareholders can escalate, leading to conflicts that disrupt business operations.

Potential areas of conflict that can be addressed in a shareholders’ agreement include: 

• Lack of Clarity on Roles: A shareholders’ agreement can outline the roles and responsibilities of each shareholder, including whether they are expected to participate in day-to-day management or whether they are simply silent investors. Without it, there may be confusion about decision-making authority and management responsibilities.
• Exit Strategy Ambiguity: The absence of provisions for selling shares or exiting the company can lead to disputes if a shareholder wants to sell their stake or in the event of a sale of the business. If a buyer wants to buy the whole company, minority shareholders could block the deal; conversely, minority shareholders could be excluded from a buy out and prevented from making a successful exit. Drag along and tag along provisions protect both larger and smaller shareholders in such a situation. 
• Valuation Issues: A shareholders’ agreement often includes mechanisms for valuing shares. Without this, determining a fair price for a private company’s shares can be contentious, particularly in cases where one shareholder seeks to buy out another. 
• Control Issues: A shareholders’ agreement can clarify which shareholders have control over key decisions and how voting in the company operates. Without this, managers may face challenges in exercising control over key decisions, especially where there are large silent investors.
• Dividend Distribution Conflicts: Without clear guidelines, disagreements may arise over how and when dividends are distributed when the company is making a profit, especially if some parties prefer to see profits reinvested or retained. A shareholders’ agreement can give authority to specific shareholders or the management board to determine a dividend strategy. 
• Dilution Concerns: A shareholders’ agreement can provide protections against dilution of shares in future funding rounds, which can be critical for existing investors. This is particularly important in growing companies. 
• Lack of Confidentiality: Without a formal agreement, protecting sensitive company information can be more difficult, increasing the risk of leaks or misuse. This can damage a business’ competitiveness. 
• Difficulties in Raising Capital: Potential investors may be wary of investing in a company without a shareholders’ agreement, seeing it as a sign of poor governance. With a shareholders’ agreement, investors will have the comfort of a predetermined framework for exits, dividends, share valuation and dilution. 
• Lack of Restrictions on Transfers: Without a shareholders’ agreement, existing shareholders may be free to sell or give away their shares to others, without requiring the company’s consent. This might leave the company in a difficult position if the new shareholder does not align with their values, does not contribute certain expertise which the previous shareholder did or is not committed to the business. 

Overall, having a shareholders’ agreement helps mitigate these risks by providing a clear framework for how the company will be governed and how shareholder relations will be managed, providing clarity and certainty both to the company and to the individuals invested and involved in it.

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