Starting a new business requires a lot of dedication and passion. This means that new business owners must pour all their time, energy, and effort into setting up their business for success in the short and long term. As entrepreneur Mark Cuban once observed, “Sweat equity is the most valuable equity there is.”
When you are building a company, it is important to follow through with the business formation process by creating blueprints for the company to follow.
This article discusses how a shareholder agreement ensures you and your partners work together effectively.
Ownership of a company is distinct from the company’s management. Shareholders comprise the ownership, while the board of directors and corporate officers are the people who have a more direct role in making most decisions. Most shareholders are not active in the operations of the business and as a result can be isolated from what is happening. Shareholder agreements will define the rights and responsibilities of all parties in a corporation. In this way, the shareholder agreement can be used by shareholders to ensure that they have the ability to limit the power of directors and have a say in how a business is managed.
A dividend is the amount of money paid to shareholders when the company makes a profit. Although it can be a while before a new company begins to make money, the time to think about dividend policies is in the beginning, before the company even turns a profit. A good shareholder agreement will include a dividend policy. Drafting the policy requires shareholders and officers to think about dividends and how they will impact how the company operates.
Large businesses with many shareholders are not the only companies who benefit from a shareholder agreement. Those of you who are in 50/50 partnerships also face challenges that can be resolved with a partnership agreement. As Will Caldwell, CEO of Dizzle, explained to Entrepreneur magazine, “a 50/50 partnership is like marriage: One partner can’t do something without the consent of the other.”
Caldwell recommends that 50/50 partners consider a shareholder agreement to help them navigate the tough questions. When two people hold equal halves of a partnership, they can be deadlocked when a conflict arises. One way to avoid a deadlock is to give a small share to a third party. The shareholder agreement then gives a stake in the business to a person that both partners like and trust. This can be a good opportunity to reward a person who has invested sweat equity into the company as an employee.
Including vesting schedules in a shareholder agreement also helps protect both parties from one partner leaving the business while still owning half of the company. Vesting schedules prevent a person from receiving their options in full right away. Instead, the vesting schedules are established to protect everyone’s interest.
For example, a standard vesting schedule gives each party 25% up front with monthly or quarterly payments up to four years.
It is imperative that a shareholder agreement include provisions on treating shareholders equally. However, what does that mean in the context of a sale? This is a very important area to elaborate on in an agreement since the way minority and majority shareholders interact during a sale will often have far-reaching implications.
Tag-along rights are also called co-sale rights. They protect a minority shareholder by giving them the right to sell shares in the event of a sale, just like a majority shareholder. This means that in a takeover or venture capital deal, the majority shareholder must include the holdings of the minority during the negotiations.
On the other hand, a drag-along provision gives more rights to the majority shareholder. The majority shareholder can require the minority shareholders to sell their shares in the event of a takeover offer. That means the minority shareholder has no choice in the event of an offer.
Majority shareholders typically do not like tag-along rights. Before you complete your shareholder agreement, be sure that everyone considers how their shares will be impacted by these concepts.
When a company is founded, its owners decide how the company will be managed. In order to be completely organized, shareholders should think through the questions listed above before finalizing the shareholder agreement. Once everyone is satisfied, adopt a shareholder agreement and follow its guidelines. By agreeing on basic ground rules, you will save yourself and your partners time and headaches in the future.