10 Reasons to have a Shareholders Agreement

A shareholders’ agreement is a binding contract between the shareholders of a company that governs the relationship between the shareholders, sets out how a corporation is controlled and lists out the rights and obligations of the company’s shareholders. In the long run, a shareholders agreement provides security and protection if relations between a company’s shareholders deteriorate.

So here we list down ten reasons why your business needs a shareholder agreement:

1. To provide dispute settlement

When a dispute emerges, a properly written shareholder agreement can provide procedures to be followed to resolve the dispute swiftly to protect the company’s business. A shareholder agreement will reduce problems and the risk of disagreement and conflict in the future. It also helps to prevent a dispute from escalating, as the provisions may assist in clearing up any misunderstanding between the parties.

2. To offer protection to the minority shareholder

A shareholder agreement can protect minority shareholders by reserving certain decisions which can only be made with the unanimous consent of all the shareholders—for instance, providing for matters requiring the approval of minority shareholders in respect of any sale of shares by the majority shareholder.

3. To include protection for the majority shareholder

A shareholder agreement may contain provisions that allow the majority shareholder to drag on the minority shareholders so that the latter can accept the offer to purchase all shares in the company.

4. To govern the management of the company

The day-to-day running of a company is generally left to the board of directors. However, the shareholders may believe that certain decisions should only be made at the directors’ discretion instead of requiring shareholders’ approval. This is especially true if some of the directors are not also shareholders. Therefore, a shareholder agreement may include measures to offer clarity and consistency regarding the business’s day-to-day operations.

The role and obligations of shareholders are also spelt out in the agreement so that each shareholder is clear about what is required of them and their level of commitment.

5. To prepare for shareholders’ fallout

No one perceives the problems during the formation of new incorporation, but once a fallout occurs, it would be almost impossible or difficult to discuss a solution or way out. It is wiser to plan the course of action if the relationship starts to go south than to take a chance waiting until points of contention are firmly established.

6. Demonstrates business stability and maturity

Having a shareholder agreement can demonstrate stability to the business and that the parties to the corporation have thought ahead to ensure that disputes can be resolved amicably and quickly.

Additionally, other parties like banks, creditors and potential investors typically want to see a shareholder agreement before investing in the company. Investors usually feel uncomfortable lending money to poorly organised corporations since they do not give a clear path for those investors to recoup their investment through dividends and channels.

Investors will carefully research the company before investing funds to make a decision that will be advantageous in the short and long terms.

7. To impose restricting covenants on the shareholder

If a shareholder wishes to leave the company, the remaining shareholders may want to restrict the shareholder’s capacity to establish or operate in a competitor’s business. Inserting a limitation or restrictions clause helps limit a shareholder’s capacity to engage in a business that competes with the company’s business and prevents the shareholder from providing services to the company’s clients or dealing with the company’s suppliers.

A shareholder agreement may also include confidentiality restrictions to protect valuable information or any secret trade key to the company’s business. Therefore, the shareholders will be under the strict duty to protect that information during and after their involvement in the company.

8. To link shareholdings to employment

A shareholder agreement can provide a mechanism whereby if a person’s shareholding is tied to their employment, they must sell back their shares when they decide to leave the company. Otherwise, an exiting shareholder can keep hold of their shares and continue to benefit from the hard work of those who remain in the business.

9. Avoiding deadlock situations

Shareholder decisions are made by voting, and a decision usually needs a majority vote to pass. Sometimes, a 75% majority is required or even unanimity. There is an impasse or “deadlock” when shareholders cannot reach a decision.

Putting a shareholder’s agreement in place before the company is formed is the best method to avoid a deadlock. A well-drafted shareholders agreement will give the shareholders and investors confidence that the business will be run efficiently, and a good shareholders agreement will include a deadlock clause. This clause aims to resolve disputes by putting a dispute resolution mechanism into play to deal with disagreements when they occur.

10. To control the transfer of shares

The other shareholders have the “right of pre-emption” over a shareholder’s shares if they want to transfer or sell them. A shareholder agreement might create a right of first refusal for shares. In other words, when one shareholder wants to sell his shares to a third party, another can refuse that sale. All shareholders have to agree about share acquisition.

Although a formal shareholder agreement is not a legal requirement in Malaysia, every company is advised to have one to ensure the company’s smooth running and the shareholders’ responsibilities are appropriately thought out. As a result, not only can it provide clarity and certainty as to what can and cannot be done, but it will also reduce the possibility of conflict between the shareholders and mitigate the loss that might be suffered from the conflict. For all the above reasons, a good shareholder agreement needs to be robust, thorough and well thought out, so all the parties can understand the structure and nature of their relationship with the corporation and one another.