Governance “Musts” – Shareholder Agreements Part I
Now that you understand the importance of why you need a shareholder’s agreement, the question now is what to include in yours? Quite often, founders treat their shareholder agreement as a bit of an afterthought, and some legal task that needs to be done by the lawyer.
However, take the long view of ten years down the line and imagine that your company has landed several massive contracts and the company is now valued at USD 1 billion. The mythical unicorn valuation. Now consider that you merrily gave away shares ten years ago as compensation for “free” work, for example your website developer who now holds 10% of your company’s shares. Because when you handed those to him, 10% of nothing was worth nothing, right? Now, entitled to 10% of your company’s dividends. Entitled to 10% of the wealth created if you manage to list on a stock exchange, the famous IPO (Initial Public Offering). For a website that was outdated years ago and has been upgraded several times since then.
This line of thinking should focus your mind considerably and treat your shares with utmost respect. They are not confetti to be tossed away at a wedding but are to be treated as though you have a billion-dollar company valuation. So, while you should get your lawyer to compile it, your shareholder agreement is yours and needs your input to guide the lawyer.
Besides the legal clauses that should be included in all properly constituted contracts, also consider some of the following principles:
- Try to have an odd number of founding shareholders to prevent voting deadlocks. This is especially important when taking highly consequential strategic decisions that could have a massive impact on the company’s fortunes.
- The ability to value the shares objectively. There are several methods to do this, based on the financial performance of the company. However, set out the method to be used so that all the shareholders agree to this method while calm heads prevail.
- Protect any Intellectual Property that could have a material impact on your company if one or more of the shareholders wish to leave. Confidentiality should be included as a matter of course.
- There should be a dispute resolution process to be invoked when the shareholders and/or founders disagree on an issue to the point that it could break the relationships so badly that the company disintegrates. This could include independent mediation or arbitration parties.
- The method to be used to dilute the shareholding of the company. This could be to an investor that takes equity in return for a capital injection that will help the business to scale rapidly. All the shareholders need to be aware of the possibility of this occurring, and to agree to the process to be followed to dilute their shareholdings. Share dilution means you lose a certain level of control BUT the value of the company should increase more than the share dilution value.
And always remember to treat your shares with respect!