Four Terms Startups Should Include in Their Shareholders’ Agreements

Written By: Missy Garska

Generally, if there are two or more shareholders in a corporation, we recommend that the parties enter into a shareholders’ agreement. A properly structured shareholders agreement can protect founders’ interests while attracting potential investors.

A unanimous shareholders agreement can create procedural conditions for transferring shares. This can include share transfer restrictions which would allow founders to restrict the sale of shares to specific circumstances, therefore safeguarding their company from being sold to someone they do not approve of.

1.       Pre-emptive rights

Pre-emptive rights give the shareholders the right to purchase the shares being issued or transferred in proportion to their existing shareholding before a third party can purchase them. This protects the shareholders’ current stake in the company.

For example, if you own fifty (50) out of one hundred (100) shares in a corporation and another forty (40) were being issued, you will have the option to purchase twenty (20) to maintain your proportion of the company.

2.       Right of First Refusal

Right of first refusal allows existing shareholders the right to purchase shares which a selling shareholder wishes to sell to a third party. This protects closely held companies like startups from having new partners without the opportunity to purchase the shares first.

Unlike the pre-emptive rights, the existing shareholder can purchase all of the shares which are being sold and increase their proportion of the company.

3.       Drag-along

Drag-along rights can be an important provision to include for a startup company as they require minority shareholders to sell their shares or vote in favour of an acquisition that they would not otherwise be required to agree to.  

4.       Vesting

One way for startups to bring in additional human capital that they may not be able to afford financially without giving away additional equity upfront is by providing shares on a vesting schedule. Vesting is a process in which ownership in shares is gained over a period of time.

This can require the employee or founder to work for the startup for a predetermined number of years or reach a certain milestone before they own the shares.

Vesting shares can also be attractive for investors as this ties founders to the success of the company. Nobody is able to leave prematurely and then benefit later from the remaining founders’ effort.

The opposite structure can be established through reverse vesting where the founder or employee receives complete ownership of their shares up front, but if the founder or employee leave the company before a set amount of time their shares are sold back to the company, often at little to no profit.

Regardless of what stage your startup is in, if you are a founder, consider consulting our solicitor team on the best way to structure your shareholder agreement to protect your interests while attracting funding.

If you require any assistance in relation to shareholder agreements, please do not hesitate to contact the writer, Missy Garska.