Just forming a company isn’t sufficient, especially when the founders expect a promising future. Just being incorporated doesn’t completely safeguard the owners’ (“shareholders”) rights. Even the company’s incorporation documents, like the Articles of Association (the “Articles”), can lead to different shareholder expectations and need clarification on how shareholders relate to each other and to the company. This is where a Shareholders’ Agreement becomes important.

Sometimes called an Equity Agreement, a Shareholders’ Agreement is a private contract that regulates the relationship between the shareholders, regulates the ownership and transfer of shares, and protects the rights of the shareholders. It also governs how the company is managed and run.

Its Importance

The main aim of a Shareholders’ Agreement is to safeguard shareholders’ investments in the company. This internal document doesn’t just add to the Articles of Association and existing corporate laws about shareholding, but it also ensures that ownership of the company, especially for small businesses, is not taken over by people who don’t own shares or manipulated by current shareholders. This is particularly important in Nigeria, where after company incorporation, someone (perhaps an accredited agent of the Corporate Affairs Commission) with the necessary information about shareholders and directors can change the ownership and management structure of the company through the post-incorporation company registration portal (CRP) of the Commission.

Apart from the reasons mentioned above that support having a Shareholders’ Agreement, here are some more reasons that highlight the significance of such an agreement.

1.    Clarifying shareholder rights, duties, and management powers.

A Shareholders’ Agreement clearly outlines what shareholders can do, how their shares are managed, and their responsibilities. It defines how and when shareholders can vote, when shareholders are liable to the company or others, and how they can offset such liabilities. The agreement also explains a shareholder’s control over their shares, how long they own them, when shares can be lost, and the rules for transferring or giving up shares. This process is called “share vesting” and is often covered by a “vesting clause.”

2.    Protecting minority shareholder rights.

A Shareholders’ Agreement secures the rights of minority shareholders or shareholders with equal stakes. By setting up a system for making decisions and limiting the power of directors, the agreement prevents directors from taking unauthorised actions.

Another way to protect the right of minority shareholders in a company is with the tag-along clauses. These clauses in a Shareholders’ Agreement give rise to a tag-along right. A tag-along right lets minority shareholders join major shareholders when the major shareholders sell shares. This helps minority shareholders sell their shares more easily during company sales or investment or venture-capital deals.

3.    Protecting majority shareholders rights.

A Shareholders’ Agreement also defends the rights of shareholders with the most shares. It does this through “drag-along clauses.” Unlike tag-along clauses, these clauses let major shareholders compel minority shareholders to sell their shares during a company sale. This stops minority shareholders from blocking or frustrating the sale by withholding their shares from sale. Interestingly, this clause can also benefit minority shareholders, as their shares are sold at the same price and conditions as the major shareholders’ shares.

4.    Securing shareholders’ pre-emptive rights.

A “pre-emptive right” means existing shareholders get the first chance to buy new shares (issued by the company or proposed to be sold by existing shareholders) before the shares are offered to outsiders. This right prevents the ownership of the original shareholders from being diluted (getting smaller) when new shares are issued. This clause signals the need to protect the interest of both existing and future shareholders in the company.

5.    Determining company’s valuation.

A good Shareholders’ Agreement decides how much different types of shares are worth at a specific time, like fair market value (current market price), net book value (recorded value) or nominal value. This “share valuation” helps set the overall valuation of the company, depending on certain events.

6.    Preventing shareholder competition.

A proper Shareholders’ Agreement includes a carefully worded “non-compete” clause. This clause prevents existing or past shareholders from using confidential company information for their advantage, especially with third parties. It makes sure the company’s business is not unfairly competed against in a certain area, place and time.

7.    Resolving disputes properly.

Similar to any well-written agreement, a Shareholders’ Agreement lays out how to handle disagreements. It might suggest starting with negotiation and moving to arbitration or even litigation, if needed. The agreement could also state the timeframe for using negotiation, arbitration, or litigation.

8.    Increasing investment chances.

 A Shareholders’ Agreement shows knowledge, professionalism, and business stability. This can help startups attract local and foreign investments.

Conclusion

The clauses in the Shareholders’ Agreement must align with those in the Articles and the Companies and Allied Matters Act, 2020 (the “Act”). If there is any conflict, the conflicting part of the Shareholders’ Agreement becomes invalid, or the whole Agreement could be void;¹ unless, of course, there is a supremacy clause in the Shareholders’ Agreement. [The Supremacy Clause often provides that in the event of a conflict between the Shareholders’ Agreement and the Articles, the provisions of the Agreement would prevail. This clause cannot override the provisions of the Act, however]. Whether or not the conflicting part in the Agreement or the entire Agreement would be void depends on the intentions of the parties to the Agreement, as may be captured in the “severability clause” of the Shareholders’ Agreement.

The reason is for the supremacy of the provisions of the Act is not far-fetched: the Act is statutory, while the Shareholders’ Agreement is personal and optional. In any case, it is best to consult an experienced corporate lawyer or firm to prepare or review a Shareholders’ Agreement. This is especially important for the success of startups.

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 END NOTE

 1. Section 288(1) of the Companies and Allied Matters Act, 2020; Longe v. First Bank of Nigeria PLC (2010) 6 NWLR (Pt. 1189) 1 S.C