Shareholders Agreement and its Role in Business

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Shareholders Agreement and its Role in Business

A shareholders agreement or a stockholders agreement, is an arrangement among shareholders that describes how a company should operate and outlines shareholders’ rights as well as obligations. The agreement also includes information regarding the management of the company and the protection of shareholders.

It is similar to a partnership agreement or an LLC operating agreement, all of these documents are agreements between owners. Nonetheless, an agreement between shareholders does not detail the operations of the company. The bylaws of a corporation describe the duties and responsibilities of the board of directors in their role of supervising the corporation’s activities.

The agreement mentioned above is just between the shareholders. But every corporation that has shareholders needs a shareholders agreement. Even if your corporation is not selling shares to the public, it is important to have an agreement. In fact, small private corporations often use these agreements more than world-famous public companies.

The purpose of a shareholders agreement is to guarantee shareholders fair treatment. It includes sections outlining the fair and legitimate pricing of shares (particularly when sold). Interestingly, it also allows shareholders to make decisions about what outside parties may become future shareholders and provides safeguards for minority positions.

Such agreements include a date; often the number of shares issued, a capitalization table that outlines shareholders and their percentage ownership. They also include any restrictions on transferring shares, details on payments in the event of a company sale. Such agreements also regulate preemptive rights for current shareholders to maintain ownership percentages.

Shareholders agreement and preemptive rights

When it comes to a shareholders agreement, it also important to discuss preemptive rights. They give a shareholder the opportunity to buy additional shares in any future issue of a company’s common stock before the shares are available to the general public. This right is a contractual clause that is typically available in the U.S. only to early investors.

It applies to a newly public company or to the majority of owners who want to protect their stake in the company when and if additional shares arrive. The U.S. company may give such rights to all of its common shareholders. Nonetheless, federal law does not require as much. If the company recognizes preemptive rights, they will note it in the company charter. The shareholder also may receive a subscription warrant enabling them to buy a number of shares of a new issue.

Preemptive rights in different jurisdictions

It is worth mentioning that, a preemptive right is basically a right of first refusal. Shareholders may exercise the option to buy additional shares. The preemptive right clause is quite popular in the U.S as an incentive to early investors in return for the risks they undertake in financing a new venture. The preemptive rights give investors the option to convert the preferred shares to common shares after the company goes public.

The use of preemptive rights in the U.S. is quite different from that of European Union nations and Great Britain. On the other side of the Atlantic preemptive rights for purchasers of stock are required by law. A preemptive right is not routinely granted to shareholders in the U.S. Several states grant such rights as a matter of law. But even these laws allow a company to invalidate the right in its articles of incorporation.

The preemptive right helps to limit the investor’s loss if a new round of common stock is issued at a lower price than the preferred stock owned by the investor. The owner of the preferred stock can convert shares to a larger number of common shares. This way it is possible to offset the loss in share value.

Preemptive rights are basically an additional incentive to early investors in a new venture. However, they have complimentary benefits for the company that awards them. It is less expensive to sell additional shares to their current shareholders than to issue additional shares on a public exchange. The savings in direct sales to existing shareholders lower the company’s cost of equity, and thus its cost of capital, increasing the firm’s value.

Preemptive rights also are an additional incentive for companies to perform well, so they can issue a new round of stock at a higher price.

Shareholders agreement and technical aspects

There are various sections included in a shareholders agreement, but they may differ slightly from company to company. The first section is the description of the parties. The section should specify as well as identify the corporation as one party and the “shareholders” as the other party.

Another section includes a list of recitals (rationale and goals for the agreement). A section about the board of directors describes how the board of directors of a corporation works, including the requirement that the decisions of the board must have a majority.

Unsurprisingly, a shareholders agreement also deals with other important topics company management and operation. This section explains how to elect directors and board officers.

Such agreements contain the rights of shareholders to hold, sell or transfer their shares. Importantly, this section might include restrictions on what happens to shares in the event of the death of the shareholder. Also, such agreements protect shareholders’ right to access quarterly reports and annual reports.
A shareholders agreement addresses other topics as well. For example, the effect of noncompliance. If a shareholder does not comply with the agreement, he or she may be removed as a shareholder. Any transfers they make would be null as well as void.

Such agreements might include a section stating that the parties agree to waive a jury trial and to settle disputes with the arbitration.

These are just some of the general sections that are often included in such agreements. A shareholders agreement is comprehensive as well as detailed enough so that all parties involved clearly understand their role.

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