Four Problems Founders May Face Without a Shareholders' Agreement

3 mins

Posted on 05 Oct 2023

Four Problems Founders May Face Without a Shareholders' Agreement

Starting a new business venture is an exciting and promising journey, but it can also be fraught with challenges and uncertainties. Ensuring a strong foundation and clear governance structure is essential to navigate potential obstacles smoothly.

One crucial document that often gets overlooked, or neglected, is a shareholders’ agreement. Without a shareholders’ agreement in place, founders open the door to problems that can hinder the company's growth and success.

Below, we explore the top four likely problems that founders may encounter without a shareholders’ agreement.

  1. Disagreements and Conflicts

In the absence of a shareholders’ agreement, disputes and conflicts among founders are bound to arise sooner or later. A shareholders’ agreement can provide a clear framework for decision-making, dispute resolution, and allocation of responsibilities. Without these guidelines, founders may have differing opinions on critical matters, such as business strategies, investments, or hiring.

Such disagreements can lead to a lack of cohesion, slowing down progress and potentially leading to the company's stagnation.

  1. Absence of Exit Strategies

A well-drafted shareholders’ agreement can include provisions that address exit strategies for founders and other shareholders. These strategies could involve mechanisms for buying out a departing founder's shares, or the right of first refusal for existing shareholders to purchase those shares, as well as timescales for an intended third party sale.

Without such provisions, founders who wish to exit the company, or to have a clear exit timetable, may face challenges finding buyers or agreeing terms, potentially leaving them with financial and emotional repercussions.

  1. Inadequate Protection for Minority Founders

In companies with multiple founders or external investors, there is often a majority shareholder or group of majority shareholders who hold significant control. Without a shareholders’ agreement, minority founders may find themselves vulnerable to decisions made by the majority that do not align with their interests.

This lack of protection can lead to the dilution of their influence or exclusion from crucial decisions, causing frustration and dissatisfaction among the minority stakeholders.

  1. Share Transfer Restrictions and Disputes

Shareholders’ agreements typically include provisions regulating the transfer of shares, such as rights of first refusal or restrictions on selling shares to third parties. Without such restrictions, founders may be tempted to sell their shares to competitors or unsuitable individuals, or at least be concerned at the possibility of others doing the same.

Moreover, the lack of clear guidelines for share transfers can lead to disputes and legal battles among founders, further destabilising the business.

In summary putting a suitable shareholders’ agreement at an early stage can prevent a number of problems which may start small but can quickly escalate when the business grows in size and value.

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Thomas Clark

Thomas is an experienced corporate lawyer who advises clients on matters including business sales and purchases, shareholder agreements and articles of association, reorganisations, preparation for sale, and employee incentives.

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The articles published on this website, current at the date of publication, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your own circumstances should always be sought separately before taking any action.

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