A shareholders’ agreement is a cornerstone document in any privately held company. Whether you’re a founder launching a startup, an early investor, or a minority stakeholder, this agreement lays the legal and commercial foundation of your relationship with the company and fellow shareholders. It governs decision-making, share ownership, dispute resolution, and exit scenarios, all essential elements to ensure transparency, reduce conflict, and support the business through various growth stages.
This article offers a comprehensive breakdown of the key clauses typically included in a shareholders’ agreement and explains their purpose, benefits, and implications in straightforward terms.
This blog is for informational purposes only, as part of our Mergers and Acquisitions Services.
Governance and Voting Rights
Shareholders’ agreement generally sets out a governance structure. It outlines how the company is to be managed, the composition and powers of the board, and the voting thresholds required for key decisions. Shareholders may agree that some resolutions require a simple majority while others like issuing new shares or altering the company’s articles require unanimous consent or a special majority. This helps balance control and gives minority shareholders a voice in critical matters.
Voting rights are usually linked to shareholding proportions, but special classes of shares may come with enhanced or restricted voting rights. Founders, for instance, often retain Class B shares or preference shares with superior voting power to maintain control even as they dilute their ownership during funding rounds. In major jurisdictions, shareholders may also have reserved matters certain decisions that cannot be made without their express consent, regardless of shareholding percentage.
Dividend Policy
The agreement may include a clause on dividend distribution. This sets out if and how the company will share its profits with shareholders. While early-stage companies typically reinvest earnings, mature businesses may offer regular dividends. A clear policy avoids disputes and ensures all shareholders have aligned expectations regarding income versus reinvestment priorities.
Dividend policies can also include provisions on cumulative or non-cumulative dividends. Cumulative dividends accrue and must be paid out before any common shareholders receive theirs, while non-cumulative dividends do not carry over if skipped.
Share Transfer Restrictions
To preserve the integrity of the share cap table, the agreement typically restricts the transfer of shares to third parties without prior approval or offering existing shareholders a chance to purchase them. Mechanisms such as the Right of First Refusal (ROFR) and Right of First Offer (ROFO) are commonly used:
- ROFR allows current shareholders to match a third-party offer before the shares are sold.
- ROFO requires the seller to first offer the shares to existing shareholders before seeking external buyers.
These rights prevent unwanted outsiders from acquiring influence and are vital in keeping the company’s strategic direction consistent. ROFR is generally considered more protective for existing shareholders, while ROFO gives sellers more flexibility.
Tag-Along and Drag-Along Rights
These rights manage what happens when significant shareholders decide to sell:
- Tag-Along Rights protect minority shareholders by allowing them to sell their shares alongside majority shareholders under the same terms. This prevents minorities from being left behind under a new ownership structure. Tag-along provisions are crucial in scenarios where control changes hands and ensure minority interests are treated equitably.
- Drag-Along Rights empower majority shareholders to compel minority shareholders to sell their shares during a company sale. This ensures that potential buyers can acquire the company in its entirety, streamlining exit processes. Drag-along rights are particularly important in venture-backed companies to facilitate full exits.
Pre-Emption Rights
Pre-emption rights offer existing shareholders the opportunity to purchase new shares before they’re offered to outsiders. This prevents dilution and allows shareholders to maintain their ownership percentages. It’s especially important for founders and early-stage investors keen to preserve their influence over the company.
Pre-emption rights can apply to equity issues or to the sale of treasury shares and may be waived with shareholder consent. In most of the jurisdictions, statutory pre-emption rights exist, but contractual rights often provide more robust and customized protection.
Anti-Dilution Protection
In down rounds i.e. when the company raises funds at a lower valuation than before, anti-dilution clauses adjust the price at which earlier investors can convert their shares to preserve value. There are two main types:
- Full Ratchet: Adjusts the share price to the new lower price, regardless of the number of new shares issued. It heavily favours investors but can be very dilutive to founders.
- Weighted Average: Adjusts based on both the new price and the volume of new shares, offering a more balanced approach. It comes in two forms: broad-based (considering all outstanding shares) and narrow-based (considering only specific groups of shares).
These provisions are vital in maintaining investor confidence, especially in volatile or early-stage markets.
Liquidation Preference
This clause determines how proceeds are distributed if the company is sold or liquidated. It ensures that preferred shareholders (typically investors) are paid before common shareholders. There are two types:
- Non-Participating: Investors either get their original investment back or convert to common shares and share in the proceeds—whichever is greater.
- Participating: Investors first get their original investment, then also share in remaining proceeds with common shareholders. This is often referred to as “double dipping” and can significantly reduce common shareholder returns.
Liquidation preferences can be capped or uncapped, and may include a multiple of the original investment (e.g., 1x, 2x). The preference structure profoundly influences founder and employee incentives at exit.
Reverse Vesting for Founders
Reverse vesting ensures that founder shares are earned over time. Although founders receive shares upfront, unvested shares can be bought back by the company if the founder exits prematurely. This aligns founder incentives with long-term company success and reassures investors that key personnel are committed.
Typically, vesting occurs over three to four years with a one-year cliff i.e. no shares vest in the first year unless the founder completes the full year. Additional clauses may include acceleration upon sale or termination without cause, which can be single-trigger (event-based) or double-trigger (event plus termination).
Deadlock Resolution
For companies with evenly split ownership or dual-founders, deadlock resolution clauses are critical. They define how disputes are handled when consensus can’t be reached. Mechanisms include:
- Mediation or arbitration
- Buy-sell clauses, where one party offers to buy out the other
- Russian roulette: one shareholder offers to buy out the other at a set price; the recipient must accept or buy them out at the same price
- Texas shoot-out: both parties submit sealed bids; the higher bidder buys the other out.
These tools ensure the company doesn’t suffer from paralysis during internal conflicts and provide fair ways to resolve impasses.
Confidentiality and Non-Compete Clauses
These clauses protect the company’s proprietary information and prevent shareholders, especially founders or employees from launching competing ventures. Confidentiality clauses typically survive termination of the agreement and prevent the misuse of trade secrets, intellectual property, and financial information.
Non-compete clauses restrict a shareholder’s ability to work with or start a competing business for a certain period and within a defined geographic area. While their enforceability depends on local laws, they are critical in safeguarding competitive advantages.
Boilerplate Provisions
Standard clauses such as notice requirements, governing law, and dispute resolution forums ensure enforceability and legal clarity. They specify communication procedures, applicable laws, and how conflicts will be resolved (typically through courts or arbitration). Other common boilerplate provisions include entire agreement, severability, and amendment clauses.
Tailoring the Agreement to Roles
Different stakeholders will value different rights. Founders benefit most from pre-emption rights, reverse vesting, and ROFR, as these provisions help maintain control and long-term commitment. Investors prioritize liquidation preferences, anti-dilution protection, and drag-along rights to safeguard and maximize returns. Minority shareholders value tag-along rights, ROFO/ROFR, and deadlock resolution mechanisms to ensure fair treatment and participation in major decisions.
When negotiating a shareholders’ agreement, it’s essential to balance protection with flexibility, enabling the business to attract investment without stifling growth or founder motivation. In multi-round investment scenarios, shareholders’ agreements may evolve through amendments or restatements to reflect updated understanding.
Conclusion
A well-drafted shareholders’ agreement provides clarity, minimizes risk, and creates a foundation of trust. It transforms a group of co-owners into structured stakeholders, aligning interests and laying down rules for collaboration and exit. Whether you are a startup founder seeking your first investor or a seasoned shareholder negotiating your rights, understanding these key provisions can safeguard your interests and ensure the longevity of your business. Always consult legal professionals to draft or review your shareholders’ agreement in line with your unique business goals and jurisdictional requirements.
A thoughtful, customized shareholders’ agreement isn’t just a legal formality—it’s an essential business tool that supports sustainable growth, attracts quality investors, and ensures that the journey from startup to scale-up is built on solid ground.
