10 of the Most Important Clauses to Put in Your Shareholder Agreement

10 of the Most Important Clauses to Put in Your Shareholder Agreement

Starting a new business has many risks, including failure to achieve a viable business model with product/market fit, excessive competition, economic downturns, lack of cashflow/runway, hiring risks, delays in delivery and technical risks. However, one of the largest risks and most common cause for business failure is due to disputes between shareholders. This article will discuss 10 of the most important clauses to put in your shareholder agreement. 1. Sweat Equity Because of the limited funds available to pay salaries, many start-up companies offer shares to co-founders and key staff who provide “sweat equity” instead of capital. When properly used, offering shares can provide a strong incentive to commit and grow the business. If the business is eventually sold or listed on a stock exchange, these shares can make initial founders and staff very rich.[1] In addition, allocating shares at an early stage usually provides significant tax advantages as any increase in the value of the shares is taxed at a lower rate or sometimes not at all. Despite the benefits of providing equity to founders and staff, problems arise if relationships with shareholders break down and people are terminated from the company. Without a valid legal agreement in place to deal with this event, such “bad leavers” will keep their shares and the remaining shareholders are stuck with minority shareholders who are now “free riding” on the efforts of the actively involved shareholders. While there are some legal “tricks” which can be used to solve this problem, such as issuing additional shares to dilute shareholders or selling the business assets to a new entity,[2] these can create grounds...