What is a shareholder agreement and why should you have one?

What is a shareholder agreement and why should you have one?

A shareholder agreement is a "playbook" between the owners of a limited liability company, setting out matters such as the exercise of control, financing and a possible exit. It is drawn up between the company's shareholders (and usually the company itself). It is not mandatory, but without one, even a small dispute can bring the business to a halt or turn corporate arrangements into a costly and slow-moving process. When setting up a company, people rarely stop to consider what happens if the owners disagree, or if someone wants to give up their shares or step away from the company's day-to-day operations. These situations occur unfortunately often, and when they do, it is in every shareholder's interest to have agreed on things in advance.

Alongside the shareholder agreement, a company has its articles of association, which bind the company and its shareholders as a matter of company law and contain the most essential provisions concerning the company, such as its field of business, along with any redemption and consent clauses.

In Finland, articles of association are mostly short and concise, which leaves many matters outside what is provided for in the Limited Liability Companies Act and the articles of association. The central purpose of a shareholder agreement is precisely to fill these gaps by contract.

There are many key reasons to draw up a shareholder agreement, but to name a few: first, it is generally good to agree on the rules in advance rather than in the middle of a conflict. One of the most common situations in disputes between shareholders is where two friends have set up a company 50/50, and in the end only one of them drives the company's affairs forward. No shareholder agreement has been made, of course, because how could a dispute ever arise between friends? Other common causes of dispute are the company's strategic and financing questions, which ultimately come down to the contract terms governing decision-making. The dispute over work contribution described above, in turn, can be avoided by agreeing in advance on work obligations and on good leaver and bad leaver terms.

Key terms of a shareholder agreement

• Objectives and principles – What the company does, how decisions are prepared, and the strategy it follows.
• Roles and responsibilities – Who is responsible for what, that is, who does the work and who finances the operations.
• Decision-making – Which matters require unanimity or a defined majority (e.g. two-thirds)? A "veto list": for example, investments above X euros, new share classes, pledges, significant contracts, dividends, and so on.
• Governance – The size and composition of the board, the chair, and rights of appointment. Information rights for parties outside the board.
• Financing and profit distribution – Any obligation of shareholders to take part in funding rounds. Dividend policy: when and on what basis distributions are made.
• Restrictions on the transfer of shares – Redemption and consent clauses. Drag-along / tag-along: the majority can "drag" the minority into a sale; the minority can "tag along" on the same terms.
• Pricing and valuation of shares – How the share price is calculated in different situations: voluntary sale, dispute, termination of employment? Valuation formula + valuer + timetable.
• Good leaver / bad leaver – If a shareholder leaves, on what terms and at what price do the company or the others buy the shares? For example, good leaver -> fair value; bad leaver -> reduced price.
• Intellectual property rights – For clarity, it is usually agreed that everything created in the course of the business belongs to the company.
• Non-compete and non-solicitation – A clear operational and time-based limitation. Recruitment restrictions, so that a departing person cannot take a team or clients with them.
• Vesting – Ownership (the redemption price) accrues over time or according to targets. Protects the company from early leavers.
• Resolving crises and deadlock situations – Usually negotiation - mediation - arbitration / the courts. A deadlock mechanism for a company with two 50/50 shareholders (e.g. a draw of lots or an external decision-maker).
• Contractual penalty and damages – A contractual penalty deters breaches, because damages claims can be difficult to prove. There is usually a cure period, for example 14 days from a notice concerning the breach, within which the conduct can be corrected.
• Confidentiality and document management – The scope and duration of confidentiality after the agreement ends.
• Entry into force, duration and updating – When the agreement takes effect, and how new shareholders are added (usually a deed of adherence). Review, for example, in connection with a funding round or a change in the field of business. Terms that remain in force despite the termination of the agreement.