When starting your company you will rightly be optimistic and excited about the future. The last thing on your mind will be what happens if you fall out with your co-founder, your co-founder wants to sell their half of the company or leaves to join a competitor. However, these are important issues that should be considered and provided for early on, when the co-founders are on good terms, rather than trying to negotiate a resolution after the relationship has deteriorated. Having a shareholders’ agreement in place will protect the interests of each co-founder and reduces the risk of something happening between the founders that will jeopardise the future of the company as a whole.
A shareholders’ agreement governing the relationship between two shareholders who each hold 50% of the company will need to cover the following 5 key issues:
How decisions are made?
How to resolve disputes?
What happens when one shareholder wants to sell his shares?
What happens when one shareholder ceases to be involved in the company?
What happens if your co-founder fails to uphold your agreement?
1. How decisions are made?
The default position under company law is that the directors will be responsible for the daily running of the company. Without a shareholders’ agreement, the shareholders will have little control over the day-to-day decisions of the company.
Where both founders are going to be involved in the day-to-day management of the company, it is sensible for both founders to be appointed directors. The shareholders agreement should enshrine this position by giving each shareholder the right to appoint a director so long as they hold 50% of the shares of the company.
Where the co-founders are not performing the same roles (for example, one founder may be actively running the company whilst the other has a more passive, investor-type, role), it may not make sense for both founders to be directors. In this instance, the shareholders agreement can limit the powers of one or more directors by preventing them from taking certain key actions without the approval of both shareholders. This will protect the investor-type co-founder without restricting the director’s ability to run the company.
2. How to resolve disputes?
Dispute resolution is the most important part of a shareholders’ agreement when both shareholders own an equal portion of the company. This is because each shareholder is reliant on the co-operation of the other. If this relationship breaks down and there is no mechanism to resolve the dispute, the company will be unable to take any actions and will ultimately fail.
The dispute resolution process set out in the shareholders’ agreement should encourage an amicable resolution to a dispute. However, if the shareholders are unable to come to an agreement, it may be necessary for one of the shareholders to exit the company (i.e. sell their shares) at a set price.
3. What happens when one shareholder wants to sell his shares?
Situations change and it may be that one of you or your co-founder wants to sell their shares and move on from the company. In such instances the non-selling founder will not want the selling shareholder to be able to sell their shares to anyone without first being consulted. The shareholders’ agreement should include transfer restrictions that limit the circumstances or people to which the selling shareholder can sell his shares. It can also provide a formula to determine the value at which the shares will be sold.
4. What happens when one shareholder ceases to be involved in the company?
It is important to think about what should happen if one of the co-founders wants to leave the company. Your co-founder may be approached by a competitor or you may decide that you no longer want to be involved in the day-to-day operations of the company.
The shareholders’ agreement should prevent shareholders from using knowledge, expertise or clients that they have gained while working at the company to get an unfair competitive advantage after leaving. This can be achieved by a non-compete clause, which restricts shareholders from working with the company’s competition for a set period of time without the company’s consent, and a non-solicitation clause, to prevent a former shareholder from taking your employees or your clients.
5. What happens if your co-founder fails to uphold your agreement?
Sadly things can break down between shareholders but you shouldn’t be left without protection if your partner doesn’t hold up their end of the bargain. Litigation is expensive, time consuming and is riddled with uncertainty. A well-drafted shareholders’ agreement will protect you without you needing to go to court, by allowing you to acquire the other shareholders’ shares for a nominal amount. This is known as a “bad leaver” provision and will only apply in very limited circumstances.
Think you need a shareholders’ agreement? Check out our template shareholders’ agreement.
You have been asked to sign a shareholders’ agreement and you’re not sure what to make of it? Check out our contract review service.
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