Why A Shareholder’s Agreement Is Important For New Venture

Most entrepreneurs understand that no man is an island and they need to work with others to bring their business to greater heights. However, without the clear structure provided by a shareholders’ agreement, business partnerships, even between close friends, frequently break down within just a few years. This can happen even when partners initially agree to manage separate areas like operations or marketing.

For instance, one unhappy shareholder decides to start a minority oppression suit to force an exit by having the court order the majority to buy out their shares, it results in at least tens of thousands spent on lawyers, lost years and mental space, and worst of all a complete breakdown in personal relationships.

Therefore, signing a shareholders agreement before starting the venture makes much more economic sense by pre-empting these issues. So, let’s explore the importance of the Shareholders’ Agreement and how its essential structure ensures it delivers these benefits effectively for most small private companies in Singapore.

 

What is a Shareholders’ Agreement? 

A shareholders’ agreement is a legally binding contract between the shareholders of a company. It delineates each shareholder’s rights, responsibilities, and the obligations of shareholders, as well as the protocols for managing the business. Unlike a company’s constitution or bylaws, which provide a general framework for the company’s operations, a shareholders’ agreement offers detailed provisions tailored to the specific needs and dynamics of the shareholders involved. 

Having this agreement in place proactively helps prevent future disagreements between owners. By establishing clear rules upfront for important issues – such as making major business decisions, distributing profits via dividends, or managing the process if a shareholder wishes to sell their shares – it ensures everyone understands the agreed-upon approach.

In contrast to the company’s constitution, which provides a general framework required by law, the Shareholders’ Agreement delves into much more specific detail. These specific provisions are carefully tailored to reflect the unique needs, dynamics, and mutual understandings of the particular group of shareholders involved.

Why Do You Need a Shareholders’ Agreement? 

1. Clearly defining “sweat equity”

Many entrepreneurs start out in a cash-strapped state. Therefore it is common for them to promise to earn their allocated shares by putting in some kind of effort, either by taking up key positions in the company or agreeing to achieve certain targets. These expectations should be clearly set out in the shareholders agreement so that it is clear whether the shareholders are living up to them, and if not, whether they should be phased out so that they do not hold back the company’s growth.

 

2. Keeping the company private

Entrepreneurs usually team up with an implicit understanding that they want to only work with each other, and not any additional parties without reaching a new consensus. However since shares are assets which can be freely traded (subject to whether a market exists for those shares), they can can form part of a deceased person’s estate, and can be willed away or distributed according to the laws of intestacy. Some shareholders get caught by surprise when their working partner dies and the family members try to get involved in the business for a range of reasons. Therefore, having the right to buy over a deceased shareholder’s shares can help to prevent such unwanted proximity to strangers.

In addition, by default a company may issue new shares and shareholders may transfer shares to third parties without requiring the incumbent’s consent. In order to keep the company within the circle of founders, the shareholders need to agree to give each other rights of first refusal or pre-emption.

 

3. Creating amicable exit options

As discussed in a previous article, most shareholders fight to get bought out. Going through adversarial proceedings is unnecessary if there is a shareholders agreement which creates conditions for shareholders to exit without having to establish blame or fault. This helps to conserve limited resources – not just time and money, but also mental space – so that the parties can move on to more productive endeavours. The positive side effect of discussing exit options upfront also helps you to discover what your other shareholders are motivated by or concerned with, and in some circumstances can even filter out future troublemakers.

 

Key Components of a Shareholders’ Agreement in Singapore 

A good Shareholders’ Agreement includes several important sections. While you can tailor these to your specific business, understanding these core parts helps create a solid agreement that protects everyone involved.

Let’s break down the essential components:

1. Shareholder Roles & Responsibilities

This section clearly defines what’s expected of each owner. It ensures everyone understands their part in the company.

Covers:

• Who contributes what (e.g., money, expertise, time).
• Any specific duties or jobs assigned to each shareholder.
• Voting rights: How much influence each shareholder has on company decisions.

Why it matters: Prevents confusion over who does what and avoids conflicts about responsibilities.

2. Board of Directors & Decision Making

This part sets the rules for how the company’s board operates and how major decisions are made.

Covers:

• How board directors are chosen, appointed, or removed.
• The number of directors on the board.
• Voting power: How decisions are passed (e.g., simple majority vote, a higher percentage like 75%, or needing everyone’s agreement).

Why it matters: Ensures fair representation and a clear process for company governance.

3. Sharing Company Profits

It’s crucial to agree on how profits, often paid as dividends, will be shared among the owners.

Covers:

• How profits or dividends will be calculated.
• How often payments might be made.
• The criteria used to decide the amount each shareholder receives.

Why it matters: Keeps shareholders happy and motivated by ensuring fair returns from the company’s success.

4. Rules for Company Shares (Issuing & Transferring)

This section controls the company’s ownership by setting rules for shares.

Covers:

• Procedures for issuing new shares (e.g., bringing in new investors).
• Rights existing shareholders might have when new shares are issued.
• The process for a shareholder to sell, gift, or pass on their shares.
• Restrictions on selling shares (e.g., needing board approval, or offering shares to existing owners first – often called the ‘right of first refusal’).

Why it matters: Helps maintain control over who owns the company.

5. Exit Plans & Share Buyouts

This prepares for situations when a shareholder leaves the company.

Covers:

• The process for the company or other shareholders to buy back shares (‘buyout’).
• How shares will be valued to ensure a fair price.
• What happens if a shareholder leaves due to retirement, death, disagreement, or other reasons.

Why it matters: Ensures a smooth and fair process when owners leave, protecting both the individual and the company’s stability.

6. Protecting Business Interests (Non-Compete & Confidentiality)

These clauses help protect the company’s valuable information and market position.

Covers:

• Non-Compete rules: Preventing shareholders from starting or joining a competing business, often for a set period after leaving.
• Confidentiality rules: Requiring shareholders to keep sensitive company information (like trade secrets, customer lists, financial data) private, even after they leave.

Why it matters: Safeguards the company’s competitive advantage and builds trust among owners.

 

Conclusion 

In conclusion, a shareholders’ agreement to start a business in Singapore is an essential tool for protecting shareholders’ interests and ensuring smooth governance. It provides a clear framework for defining roles and responsibilities, establishing decision-making processes, resolving disputes, and managing share transfers. By carefully drafting a comprehensive shareholders’ agreement, you can prevent conflicts, safeguard your investments, and foster a collaborative and transparent business environment. 

This is a collaboration article with VanillaLaw.

For more information or legal assistance, you may contact Boon Gan of VanillaLaw LLC at [email protected] or via WhatsApp at (+65) 8620 8629.