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When starting a corporation with others, it’s easy to focus on the opportunities and overlook the risks. Beyond competition and product viability, one of the biggest risks is internal conflict. A well-crafted shareholder agreement can be the key to mitigating this risk and maintaining harmony among shareholders.
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What Is a Shareholder Agreement?
A shareholder agreement is a confidential contract between some or all of the shareholders of a corporation. It outlines the rights and obligations of shareholders, how shares will be managed, and protections for shareholder interests. Unlike corporate bylaws or Articles of Incorporation, which are often public, a shareholder agreement is private, offering a tailored, flexible way to manage internal relationships and expectations. See our step-by-step guide to corporate bylaws to understand how they differ from shareholder agreements.
States don’t typically require corporations to have a shareholder agreement, but it’s highly advisable to have one. Without it, state default laws dictate shareholder rights, which may not align with your needs. Worse still, if state law doesn’t address an issue, disputes may have to be settled in court, which can be costly and damaging to your business.
When Is a Shareholder Agreement a Good Idea?
If your corporation has more than one shareholder, you need a shareholder agreement. Even in family-owned businesses, disputes can arise unexpectedly. Having agreed-upon terms in writing helps ensure smooth decision-making and prevents family conflicts from affecting the business.
Example: Imagine your family owns Techy, Inc., and your brother Mark passes away. Without a shareholder agreement specifying how shares should be handled, Mark’s ex-wife could inherit his stake, causing tension. A shareholder agreement could have included a provision requiring Mark’s shares to be sold back to the company under such circumstances, preserving harmony.
Articles vs. Shareholder Agreement
Many corporations rely on Articles of Incorporation for shareholder protection. However, Articles are typically filed with the state and therefore public, meaning they often lack the level of detail and flexibility a corporation needs. Amending Articles is also more challenging compared to updating a shareholder agreement, which can be customized and remain private among shareholders.
A shareholder agreement offers a more robust solution, covering topics such as share valuation, voting rights, and buy-sell arrangements that Articles may not comprehensively address.
Maintaining Control Over the Company
A shareholder agreement also helps shareholders establish control over the corporation. While directors typically hold broad decision-making powers under corporate law, shareholders can use a shareholder agreement to restrict or guide these powers. For example, shareholders can decide which matters require a vote rather than leaving everything up to the board of directors.
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Why Investors Care About Shareholder Agreements
Investors like to see a solid shareholder agreement. It shows stability and provides clear rules for how potential issues will be resolved. Before investing, many angel investors review legal documents, including the shareholder agreement. If they see a well-structured agreement, they know there is a plan for managing disputes, ownership, and governance. A lack of an agreement can be a red flag and might make investors move on to other opportunities.
Confidentiality and Non-Competition Clauses
Shareholder agreements can also include provisions to prevent shareholders from disclosing company secrets or competing with the business. Imagine a situation where Mark, a former shareholder, uses insider knowledge to create a competing business. A confidentiality or non-competition clause in your shareholder agreement could prevent this from happening, protecting your competitive advantage.
Intellectual Property Protection
Often, founders start developing intellectual property before the corporation is officially formed. Without a shareholder agreement that addresses IP rights, disputes may arise if a shareholder leaves while holding valuable IP. A shareholder agreement can specify that IP created by shareholders for the corporation must be transferred to the company, ensuring its continued ownership and use.
When Should You Create a Shareholder Agreement?
The best time to create a shareholder agreement is at the beginning, when relationships are good and trust is high. Waiting until a conflict arises can make it difficult to reach an agreement. Setting clear expectations from the start helps avoid misunderstandings and ensures everyone is on the same page.
Do I need a lawyer to start a business?
The biggest question now is, "Do I need a lawyer to start a business?” For most businesses and in most cases, you don't need a lawyer to start your business. Instead, many business owners rely on Legal GPS Pro to help with legal issues.
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Protect your business with our complete legal subscription service, designed by top startup attorneys.
- ✅ Complete Legal Toolkit
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