Stockholders Agreement

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Stockholders Agreement

Brief Introduction about Stockholders Agreement

A shareholders agreement is an arrangement that is laid between the company and the shareholders describing the company’s operations and the rights and duties of the shareholders. The stockholders definition could be defined as having pointers that help in protecting the rights and privileges of the shareholders. It also outlines all the management related information that is appointed for the smooth functioning of the company. The purpose of a stockholder’s agreement is also to define the valuation of shares and rules that are required to either transfer the shares or sell them in case of a buy-out. For smaller startups, a stockholder agreement can cover the company partners that are contributing their talent and/or assets to the company.

When Do You Need Stockholders Agreement?

Privately held companies require stockholders or shareholders’ agreement to outline the company’s functioning. An ironclad agreement between the stockholders helps in getting a lot of clarity in terms of the invested amount, asset division, and profit-sharing. At the same time, it helps in identifying the major and minor shareholders that offer value to the company. Such agreements are often viewed as a means to minimize inequality of positions and protect the rights of minority shareholders. The agreement can also lay down a set of rules that helps in governing the company and how future matters might go a particular route for resolution.

Additionally, it also provides information regarding how the company will function and how the board of directors will be appointed. In case a company eyes to grow for a merger or a buy-out, the agreement helps in clearing the process and ensures the shareholder’s rights are intact.

Inclusions in the Stockholders Agreement– Inclusions

A typical stockholders agreement covers the following points –

  1. Provide information regarding the rights of stockholders and their obligations towards the company.
  2. The agreement comes with information and rules regarding the company’s functioning. It can be critical in terms of appointing a board of directors and also define the foundation on which the company is going to run.
  3. Minority Partner protection is also an important aspect of a stockholders’ agreement. It ensures that there is no inequality between the shareholders when it comes to decision making and operations of the company.

How to Draft the Stockholders Agreement

While drafting a stockholder’s agreement, the following points should be considered:

  1. The stockholders’ right should mention the name of the stockholder and the company, along with the shareholding percentage held.
  2. It should define the commercial intent of the company and how the stockholders come into play.
  3. The classification of shares should be done legally. The type of share can differ from equity, preference, hybrid securities, debenture, and more.

Benefits & Drawbacks of the Stockholders Agreement

Pros:

  1. It helps in maintaining an element of privacy regarding the company’s shareholders and the internal functioning of the company.
  2. It helps in avoiding any future disputes amidst the shareholders regarding the profit sharing of the business.
  3. It can ensure that stockholders don’t create a competitive company as long as they are a part of the current company.

Cons:

  1. A stockholders’ agreement can lose certain governing flexibility due to such shareholders’ rights.
  2. Majority shareholders might see the protection clauses for minority shareholders as an issue, especially during decision making and selling their part of the shares.

Types of Stockholders Agreement

The types of Stockholders Agreement include

  1. Minority or Equal Stockholdings : Such an agreement is designed to comprise of provisions that protect the minority shareholders or for the members who share an equal stake in the company. The agreement ensures that minority stockholders aren’t held to ransom by majority stockholders, especially in a private company. Such clauses minimize the abuse of power by one or two stockholders.
  2. Majority of Stockholders Agreements : Many private companies can have a single major stockholder that owns more than 50% of the company. In such a case, an agreement helps in identifying the powers of the stockholder and the appointment of the board representatives. It can help be used to lay out the rules for dispute resolution and selling of the shares.

Key Terms in Stockholders Agreement

The key terms of a stockholder’s agreement involve –

  1. The commercial intent of the company and its operational structure.
  2. Terms of the deal, including the different share types, its value, and ownership of different types of securities.
  3. Investment protection with board representation and rules for budget planning and financial reports.
  4. Restriction of transfer to ensure none of the stockholders sell their share to a third party without the written approval of the current stockholders.
  5. Termination clause that helps in avoiding pitfalls and protecting the company against specific events or breach.

What Happens In case of Violation

Depending on the creation of the stockholders agreement, the terms for violation or breach of contract differ. In most cases, if a stockholder breaches the contract, the other stockholders can argue regarding the issue and can suspend the stockholders’ voting rights or recover the damage incurred to the company. In a few cases, the stockholders can either force the violating member to sell their shares or even file an injunction in the court of law to receive additional compensation for the damage.

A stockholders agreement can be beneficial for companies that have a mix of majority and minority shareholders. It can be used as a safeguard as a means of additional protection for the shareholders. Such an agreement can also boost the confidence of your investors and ensure that the company has a sound plan to execute.

Sample for Stockholders Agreement

A sample of the agreement can be downloaded from below.

 

Stockholders Agreement Template- Download PDF

Stockholders Agreement

 

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