Why Shareholder Agreements May Be Critical for Your Business

I’ve discussed previously the importance of shareholder agreements for startups and small businesses with multiple founders/owners. I’d like to bring up a few more issues that underscore why shareholder agreements are critical for startups and small businesses.

While shareholder agreements can define the rights and responsibilities of founders and other significant shareholders like private equity investors and protect them from each other, shareholder agreements can also protect minority shareholder groups, such as seed investors and employee equity holders. Not only can a shareholder agreement with minority shareholders provide protections for the minority shareholders as against majority shareholders and vice-versa — for example, employee shareholders (even if they are a minority as a whole) who have voting rights can agree to the founders to the board or vote along with the founders’ vote, so as to avoid a situation where the employees become a rogue voting group!

Shareholder agreements are also important for providing stability and continuity in the event of some sort of “traumatic” event, such as the departure of a founding shareholder or attempted takeover or expulsion of one or more founding/managing shareholders by the inclusion of provisions such as right-of-first-refusal (for significant shareholders who wish to depart) or so-called “shotgun” clauses (which prevent against internal takeovers by allowing the other shareholders to force a purchase of the shares of the shareholder attempting the takeover at the price per share that shareholder offered to buy out).

For all of the reasons why a shareholder agreement may be an important document for startups and small businesses, perhaps none is more compelling than the fact that a shareholder agreement solves a number of issues that would otherwise only be solved through squabbling lawyers or litigation, either of which can be an expensive (to the tune of tens of thousands of dollars) proposition. In contrast, a shareholder agreement costs, at most, a few thousand dollars in legal fees to have drafted. If your company has the funds to afford it, a shareholder agreement can be one of the best legal investments your company can make — for as they say, an ounce of prevention is worth a pound of cure.