Although a company’s Articles of Association are essential for its incorporation, they often fail to address issues that arise once the business begins to grow. Disputes between shareholders, the departure of one of the company’s founders, or actions by a shareholder that are detrimental to the company are all situations in which a well-drafted Shareholders’ Agreement (SHA) can save months of costly disputes.
A Shareholders’ Agreement is not a mandatory document. However, it is worth considering alongside the company’s articles of association, particularly in high-growth companies, businesses where one or two shareholders (or management board members) play a key role, or companies with a significant imbalance in share ownership between shareholders.
Why do shareholders need an SHA if they already have the Articles of Association?
The Articles of Association are a public, registered document and, by their nature, relatively general. Their purpose is to regulate the company’s legal structure without going into the detailed allocation of responsibilities, roles, or relationships between shareholders.
An SHA, on the other hand, is a separate and confidential agreement between the shareholders. It is not filed with the commercial register and is therefore not publicly available. It often sets out the rules governing shareholders’ exit from the company, the division of responsibilities, the consequences of disputes, and mechanisms for resolving them.
What happens if one shareholder wants to sell their shares?
Two key provisions that should work together in an SHA are the tag-along and drag-along clauses.
A tag-along clause (right to join a sale) gives the remaining shareholders the right to participate in a share sale on the same terms if one shareholder finds a buyer. This clause protects minority shareholders from being left in the company with an unknown or unwanted new shareholder who has acquired another shareholder’s stake.
A drag-along clause (right to force a sale) works in the opposite direction. It allows the majority shareholder(s) to require the minority shareholders to sell their shares together with them when an offer is made to acquire the entire company. This clause protects both the majority shareholder and a prospective investor by ensuring that the buyer can acquire 100% of the company without being forced to continue operating alongside minority shareholders who refuse to sell.
Without these clauses, the sale of the entire company may be blocked because a single shareholder refuses to approve a transaction that benefits everyone else. Conversely, a majority shareholder may sell their stake, leaving minority shareholders tied to a company now controlled by an unfamiliar new owner.
What happens if a shareholder leaves the company?
This is arguably one of the most important aspects of an SHA.
Good Leaver and Bad Leaver clauses determine what happens to the shares of a shareholder who ceases to be actively involved in the business.
A shareholder who leaves in good faith—for example due to health reasons or with the consent of the remaining shareholders—will generally qualify as a Good Leaver. In such cases, their shares are typically purchased by the remaining shareholders or an investor at fair market value.
By contrast, a shareholder who leaves because of misconduct—such as breaching a non-compete obligation or disclosing the company’s confidential information—may be classified as a Bad Leaver. In these circumstances, the value of their shares is often deliberately discounted as a contractual consequence of the circumstances surrounding their departure.
It is essential to define the specific situations that qualify as Good Leaver or Bad Leaver events before any conflict arises between the shareholders—ideally in the Shareholders’ Agreement itself.
How can the company’s know-how and business relationships be protected?
A confidentiality clause should cover not only financial information but also the company’s know-how, customer database, and commercial terms, such as pricing policies, discount structures, price lists, and profit margins. The obligation should apply not only during the shareholders’ cooperation but also for a specified period after a shareholder leaves the company.
A non-compete clause protects the company from a situation where a departing shareholder establishes a competing business using the contacts, expertise, and knowledge acquired while involved in the original company.
It is important to define precisely what constitutes competitive activity or confidential information, how long the confidentiality and non-compete obligations will remain in force, and, where applicable, the geographical scope of the non-compete restriction.
Can a shareholder be prevented from leaving during the company’s early years?
Yes. This is the purpose of a lock-up clause, which temporarily prohibits shareholders from transferring or selling their shares.
Its primary objective is to protect the stability of the founding team during the early stages of the business, when the departure of one founder could threaten the company’s future.
A lock-up clause is particularly important where the company’s value is based primarily on the founders’ expertise, know-how, relationships, and personal involvement rather than on tangible assets.
Final thoughts
A Shareholders’ Agreement can be signed at any stage of a company’s existence—it does not have to be executed when the company is incorporated.
However, the best time to enter into an SHA is when the shareholders still have a good working relationship and can negotiate its terms constructively. Once a serious conflict has arisen between the shareholders, reaching agreement on such a document becomes, in practice, extremely difficult.
