A Well-Functioning Shareholders’ Agreement for a Startup 1/2

One of the key issues in running and maintaining a successful business is to minimise legal risks, also known as unnecessary expenses. Things do not always go as in the movies, but sometimes they do – unfortunately: we all remember what happened in ‘The Social Network’, and nobody wants to experience the same, right?

A shareholders’ agreement (SHA) is an agreement between the shareholders of a company. It is one of the most important ways to avoid trouble in the future. Briefly put, the SHA defines how the company is run by the shareholders and the board of directors, what kind of consents are required in decision-making, and how the shareholders may deal with their shares. Together with the Companies Act and the articles of association, the SHA forms the legal spine of the company.

When starting a company, the parties are all dazzled with excitement, 100% sure that their startup will shake the market and confident that all the founders are motivated and will be working as hard as possible to succeed. However, the first steps in the life span of a startup may be difficult. There is no money coming in, and uncertainty about breakthrough may create dissent or cause some of the shareholders to lose their interest in the whole project. Under these circumstances, it is very important that each of the shareholders is aware of what is in question in the business, what will happen when certain events occur and what is expected from each shareholder.

In our blog post, we will list the most important issues that should be taken into consideration and clearly specified in the SHA. In the first part, we will concentrate on two topics: specifying the roles of the parties and protecting intellectual property rights. In a later post, we will go through three other vital concerns.

Administration and Roles of the Parties

Primarily, the SHA should define the objectives and roles of the parties so that each of the shareholders has a comprehensive idea of its own roles, duties and responsibilities, as well as those of the other parties. This is essential especially in the case of startups, which typically have only a few shareholders who are all tightly involved in managing and running the business.

The purpose of the SHA is to control the decision-making, especially when investors enter the picture. In the beginning, the company often needs to reform its practices, strategies and operation models along the way. Here, agility is key: it is not possible or indeed advisable to bind the company to a fixed long-term plan that cannot be improved if needed. If you are the founder – which probably means you are also the majority shareholder – you want to make sure that all the decisions that need to be made in the company actually get made, whether they are about nominating the board members, raising money or selling the business. However, the parties may have quite diverse objectives and opinions about these issues. In addition, investors also want to have a say in these matters.

The SHA must be prepared carefully. It should give reasonable rights to all parties but keep you in control of the crucial matters. It should specify particulars, such as the number of board members, how new board members may be nominated, the voting system and possible observer rights to investors that are not represented in the board. Furthermore, the SHA should include a list of reserved matters, which can only be decided by a qualified majority or with the prior written consent of one or several shareholders. Reserved matters include amendments of the articles of association, issues of equity securities and other important decisions.

Protecting Intellectual Property Rights and Know-How

The SHA must include a provision ensuring that all the intellectual property rights (IPRs) as well as all technical capabilities, expertise and know-how which have arisen or will arise later in conjunction with the business of the company remain its exclusive property. If a shareholder enters into the SHA with some IPRs of their own, the SHA should state that in certain cases these rights must also be vested in the company as the absolute legal owner and beneficiary. This is particularly true when such IPRs are related to the preparation of the startup.

Having exclusive rights to its intellectual property is highly important for your startup for multiple reasons. For example, for many startups the IPRs may be the only valuable property, which makes them crucial for both the company and the investors.

In the next part of this blog post, we will tell you more about getting prepared for leaver situations, restricting transfer of shares and other essential provisions that should be included in the SHA.

Tuomas Honkinen