Why Start-ups Should Have a Shareholders’ Agreement and Key Clauses to Include

‍Introduction

Starting a new business is always exciting, and entrepreneurs are often driven by optimism and ambition. However, this enthusiasm should not come at the expense of proper risk management. One of the most effective ways to safeguard your business from potential disputes and uncertainties is by having a clear agreement between business owners.

There are various legal structures available for businesses in Malaysia, including partnerships, limited liability partnerships (LLPs)[1] and private limited companies (Sdn Bhd). This article focuses on companies and the importance of executing a Shareholders’ Agreement among business owners to define their rights, responsibilities, and expectations.

What is a Shareholders’ Agreement?

A Shareholders’ Agreement is a legally binding contract between the shareholders of a company that outlines their respective rights, obligations, and responsibilities. While it is not legally required in Malaysia, a Shareholders’ Agreement helps prevent misunderstandings, ensures smooth business operations, and provides mechanisms to resolve disputes efficiently.

Why Do Start-ups Need a Shareholders’ Agreement?

Many start-ups overlook the importance of a Shareholders’ Agreement, assuming that mutual trust and verbal agreements are sufficient. However, as businesses grow, conflicts and differing priorities often emerge. A well-drafted Shareholders’ Agreement can mitigate risks and safeguard the interests of all shareholders.

1. Clarity in Decision-Making

Without a structured decision-making process, disagreements between shareholders can paralyse business operations. A Shareholders’ Agreement sets out how key decisions are made, preventing conflicts among shareholders. It can specify voting rights, decision-making thresholds, and how disputes should be resolved.  By establishing these rules early on, start-ups can prevent conflicts that arise from unclear governance structures.

2. Protection for Founders and Investors

Start-ups frequently seek funding from investors, which can introduce complexities regarding control and ownership. A Shareholders’ Agreement can protect the founders' interests while ensuring investors' rights are defined.  It can include clauses to prevent early exits or changes in shareholding without consent.  By outlining these terms clearly, a Shareholders’ Agreement balances the interests of both founders and investors, fostering a stable business environment.

3. Exit Strategies and Dispute Resolution

It must be borne in mind that not all businesses succeed, and even successful ventures experience ownership changes over time. A Shareholders’ Agreement should address:

• How shares should be transferred if a shareholder wants to exit.
• Pre-emption rights, which give existing shareholders the first right to purchase shares before they are offered to external parties.
• Dispute resolution mechanisms, such as negotiation, mediation, arbitration, or litigation, to handle conflicts effectively.

This ensures that a smooth transition process is in place, preventing disruption to business operations.

4. Safeguarding Business Continuity

Start-ups are vulnerable to instability when key stakeholders depart due to unforeseen circumstances such as death, incapacity, or financial distress. A Shareholders’ Agreement can include:

• Buyout provisions, ensuring that remaining shareholders have the option to buy the shares of an exiting partner.
• Drag-along and tag-along rights, which protect minority shareholders when a major shareholder sells their stake.
• Succession planning, ensuring that the business remains stable even if a founding member is no longer involved.

These provisions help businesses maintain operational stability, regardless of changes in ownership.

Key Clauses to Include in a Shareholders’ Agreement

Having a Shareholders’ Agreement is not just about drafting a standard template; it should be tailored to fit the specific needs of the business. Here are some critical clauses that should be included:

1. Rights and Responsibilities

Outlining the rights and responsibilities of each shareholder is crucial. There are different mechanisms for different goals. For example, a shareholder who prefers financial returns over management involvement may opt for preference shares instead of ordinary shares. It is also important to make it reasonably clear how and when dividends will be distributed.

2. Shareholding Structure

This defines each shareholder’s ownership percentage, and it does not have to be an even split among the shareholders. It is subject to negotiation between the parties, and it usually would take into account factors such as financial contributions provided by each shareholder, as well as the different roles and responsibilities of each shareholder.‍

‍3. Transfer of Shares

Establishing clear rules on how shares can be sold or transferred is crucial, particularly when shareholders contribute not just financially, but also through their expertise and experience. In such cases, an unrestricted transfer of shares could be detrimental to the business. However, the objective of a Shareholders’ Agreement is typically to provide clarity rather than impose absolute restrictions. Clearly defined terms ensure all parties are aligned, reducing the risk of misunderstandings or disputes.

4. Dispute Resolution

When starting a business, entrepreneurs rarely anticipate disputes. However, conflicts can and do arise, particularly when challenges emerge. A well-drafted Shareholders’ Agreement helps prevent misunderstandings, but if disputes do occur, a clear dispute resolution clause is essential. This clause should outline how conflicts will be managed, whether through negotiation, mediation, litigation, or arbitration. Resolving disputes through negotiation or mediation can save significant time and costs, allowing you to focus on what truly matters—running and growing your business.

Conclusion

A Shareholders’ Agreement is an essential document for start-ups, providing clarity on ownership, decision-making, and dispute resolution. Without one, businesses face legal uncertainties, conflicts, and potential financial losses.

To ensure a well-structured, legally sound Shareholders’ Agreement, it is advisable to consult a corporate lawyer who can tailor the agreement to your business’s unique needs.

This article is written by Raja Nadhil Aqran (Partner). It only contains general information. It does not constitute legal advice nor an expression of legal opinion and should not be relied upon as such.

For more information, contact us at info@aqranvijandran.com.

[1] See the article entitled “The Basics of Limited Liability Partnerships and 5 Reasons They May Be Right for You” written by our Partner, Vishnu Vijandran: https://www.aqranvijandran.com/blog/the-basics-of-limited-liability-partnerships-and-5-reasons-they-may-be-right-for-you.

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