Shareholder Agreement

What is a Shareholder Agreement?

A shareholder agreement outlines how a company is to be operated, the rights and obligations afforded to the shareholders, and the relationship between the company and the shareholders. It is similar to a partnership agreement, which is an arrangement between the various partners in a business.

The purpose of a shareholder agreement is to ensure that shareholders are protected and treated fairly, and it allows them to make decisions on the third parties who may become shareholders in the future. Although it is designed to protect all shareholders, a shareholder agreement is more important to minority shareholders since it outlines the majority shareholders’ obligation to protect minority shareholders against abuse and give them a voice when key decisions are made.

Shareholder Agreement Explained

The shareholder agreement helps protect the interests of current shareholders from cases of abuse by future management. If there is new management or the company is acquired by another entity, the agreement helps safeguard certain decisions such as dividend distribution and issuing of new stock or debt.

Some of the issues covered in the shareholder agreement include dealing with shareholders’ issues, corporate distributions, the management team of the company and limitation on authority, rights of minority shareholders, valuation of shares, voting of shares of stock, restrictions on the transfer of shares, allotment of additional shares, etc. The agreement protects shareholders, and it can be used as a reference document if there are disputes in the future.

How Shareholder Agreements Protect Minority Shareholders

Minority shareholders lack voting control of the company, and in the absence of a shareholder agreement, these shareholders will exert minimal influence in the running of the company. Key management decisions can be made by the few controlling shareholders who own more than 50% of the company, and they may not consider input from the minority shareholders.

Even if the articles of association protect the minority owners, the provisions can often be altered through special resolutions approved by the majority shareholders. The shareholder agreement may address these loopholes by requiring that key company decisions be approved by all shareholders regardless of their voting power.

Such rules limit the ability of the majority shareholders to overrule minority shareholders when making certain decisions, such as the issue of new shares, taking new debts, and the appointment and removal of directors, etc.

How Shareholder Agreements Protect Majority Shareholders

Apart from protecting the minority shareholders, the shareholder agreement may also protect the majority shareholders where minority shareholders are uncooperative. For example, majority shareholders may require the inclusion of a drag-along provision that allows them to sell part or all of the shares at a specific time and price even if the minority shareholders are unwilling to agree on the transaction.

Also, the shareholder agreement may include a clause that prevents minority shareholders from transferring their shares to a competitor or other party that majority shareholders do not want to get involved in the company. The agreement should also define rules on the sale and transfer of shares, who can purchase shares, the terms and prices, etc.

What is Included in a Shareholder Agreement?

The contents of a shareholder agreement may vary across companies. Some of the contents of a shareholder agreement include:

1. Parties

The first section of a shareholder agreement identifies the corporation as one party that is different from the shareholders (another party).

2. Board of Directors and Board meetings

The shareholder agreement describes the role of the board of directors in the company and the requirement that decisions of the board should be approved by the majority. It also states how frequently the board of directors should hold meetings and how directors are selected and replaced.

3. Reserved Matters

The shareholder agreement should set out issues that cannot be passed without getting the approval of all signatories, not just majority support. By creating a list of reserved matters, all shareholders are given the chance to vet certain transactions to determine if they are prejudicial to their investment.

Some of the commonly reserved matters include changing share capital, acquiring or disposing of certain assets, taking on new debt, paying dividends, and changing the articles of association and memorandum.

4. Shareholder Information and Meetings

The shareholder agreement should include a requirement that shareholders are entitled to regular updates on the company’s performance through quarterly reports and an annual report. It should state the specific period when the reports should be sent out to shareholders. The agreement should also state when shareholder meetings will be held and the time, date, and venue of the meetings.

5. Share Capital and Share Transfers

The shareholder agreement should record the corporation’s share capital at the date when it is signed. Since changing share capital is one of the reserved matters, the directors are prohibited from issuing new shares or changing existing shares into a new share class without the signatories approving the changes.

The shareholder agreement also contains provisions relating to share transfer, such as preventing share transfer to unwanted parties, transferring shares to a new party, what happens if a director or shareholder dies, as well as drag and tag provisions.

6. Amendment and Termination

The process of amending or terminating the shareholder agreement should be provided in the agreement. For example, the shareholder agreement may be terminated upon the dissolution of the company, based on a written agreement, or after the lapse of a specific number of years from the date of the agreement.

More Resources

CFI is the official provider of the Financial Modeling & Valuation Analyst (FMVA®) certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, the following additional resources will be very helpful:

• Board of Directors
• Proxy Vote
• Shareholder Letter
• Voting Shares
• See all valuation resources