Should Startup founders have a shareholders agreement?
10 mins • 09 Sep 22
Yes! The founders of any company should always enter into a shareholders agreement (SHA) as a key means of ensuring founder alignment and avoiding future disputes.
The shareholders agreement sets out the rights and obligations of each founder and the board of directors.
Note, the SHA is not the same agreement that a founder might use to acquire their shares in the first place.
A good shareholders agreement would typically address the following:
Composition of the Board
It is very common that venture investors will require that all shares and options held by the founders (and other employees) of the Startup be subject to vesting.
Vesting is the process / period that must have been satisfied before a person/entity has the full right/entitlement to the stock that is subject of the vesting scheme.
Without a vesting concept, it could be the case that one or more founders could simply leave the Startup whilst still being able to retain their shares.
The founders are obviously the driving force of the Startup and if they are not locked into the business in a meaningful way, the value proposition that the Startup represents is diminished.
Indeed, this can create significant issues including including making fundraising very difficult. Investors will want to see founder talent locked into the Startup project.
As such, the founders should consider the inclusion of vesting conditions into either the SHA or in stock purchase agreements entered into at the time the stock is issued to the founders.
In terms of "vesting" market practices, it is noteworthy that in Silicon Valley the typical vesting period is four years. The vesting schedule typically is typically 25% of the shares vesting after 1 year of service and then an equal percentage of the remainder of shares vesting for the remaining 36 months.
If a founder stops providing services to the Startup, then the company can take back the unvested shares or options held by the founders.
The transfer of shares
Founders typically own all of the shares in the Startup and this can give rise to certain complications. As such it is important to consider limits on when shares can be sold or otherwise transferred.
Founders typically have a right of first refusal on the transfer of shares. How this works is that the founder who wishes to sell would let the company and/or other founders know that they wish to sell. The company and/or founder would then have the right to buy the shares on the same terms and conditions offered by a third-party purchaser.
Co-sale rights are also potentially important, where the right of first refusal is not exercised. In this case a co-sale right allows the other founders to participate with the selling founder in selling a pro rata amount of their own shares to the third-party purchaser.
Whether or not shares can be sold to competitors is something that founders should focus on.
If the above types of matters are not dealt with in the company's Certificate of Incorporation or bylaws (the organizational documents), they they will likely not exist.
As in the case of vesting, some of these terms may also appear in the founder stock purchase agreements.
Special voting rights − protective provisions
Shareholders may wish to retain the right to approve certain matters that impact the company. Ordinarily, for most businesses, most company business matters are determined by the board or company senior executives.
The kind of matters where shareholders may wish to reserve the right to approve things might include:
- incurring debt over a specific amount
- issuance of preference shares
- issuance of any equity security senior to common stock
- the sale of the company
- significant changes company's business
- changes to founder compensation
Founders, understandably, view these types of issues as being particularly important. In such cases, they may even require a supermajority (instead of just a simple majority) vote before they could be undertaken.
Founders frequently find themselves short on time or funds for legal budgets, so we frequently see that founders quite often fail to address the above critical type of issues.
Instead, founders are often content for existing law and/or their organizational documents control these issues. That may or may not prove to be the best position.
The founders should come to an agreement on these concerns early on; then, should an issue arise, there is a clear way of dealing with it.
Shareholder agreement templates - how we can help
Founders can obtain an excellent shareholder agreement template from the GLS Start Up Legal Support Centre.
Starting with the correct template will help ensure your SHA covers the ground that it needs to including: board composition, vesting, share transfer, special voting rights, representations and warranties, closing date, minority shareholders, provisions around selling shares, number of shares, majority shareholder rights, relationship with articles of incorporation, etc.
You can also access a wide range of shareholder related agreements from the GLS Start Up Legal Support Centre including:
Variable share purchase agreement templates
Depending on your start up - you might need a short form agreement or perhaps a long form agreement. We have templates available to reflect the complexity of your shareholder arrangements.
Shareholder loan templates
Shareholders are often the source of funding for your Startup business. As such, shareholder loan arrangements should be adequately documented. Your shareholder loan agreement should operate in conjunction with your shareholder agreement.
If you would like to see a sample shareholder loan agreement please click here.
When it comes to legal basics, it can seem overwhelming at first. But, it doesn’t have to be. GLS offers a host of free Startup resources to help set you on your way. You can also browse our list of over 200 Legal Templates and Tools, to choose the products your Startup needs at each critical stage of business.
We also offer a wide range of subscription based Legal Support Plans created specifically for Startups who want a 360 degree service in creating their own virtual legal dept.
*The above content does not constitute, nor is it offered as, legal advice of any kind. GLS Solutions Pte Ltd is not a law firm and any support provided pursuant to this entity is not regulated legal advice or legal opinion.
Conclusion: A shareholders agreement for Startups is a good idea
Act in haste and repent in leisure - these are wise words. Founders tend to have a myopic focus on the launch of the business as opposed to ensuring founder alignment.
Working through a robust shareholder agreement template will help founders test and document true alignment - making them a far more formidable and productive force for the benefit of the Startup.