Shareholder Agreement Review: What Founders Should Put In Writing Early

Starting a business with co-founders or investors is exciting, but it is also a critical time for setting the ground rules. Many founders make the mistake of relying on informal agreements, handshake deals, or vague emails when it comes to ownership and decision-making. Unfortunately, these shortcuts can lead to confusion, disputes, or even legal battles down the road. A shareholder agreement review is one of the most important early steps you can take to protect your business and your relationships. This guide covers what to put in writing, common mistakes, state law caveats, and practical checklists to help you get it right from the start.

What Is a Shareholder Agreement and Why Is It Important?

A shareholder agreement is a private contract between a company and its shareholders. It sets out the rules for how the company will be run, how shares can be bought or sold, and what happens if there is a disagreement or a founder leaves. While not always required by law, a clear shareholder agreement can prevent disputes, protect founder interests, and provide a roadmap for decision-making.

At the federal level, there is no law that requires a shareholder agreement for corporations. The IRS and SBA recommend keeping clear records of ownership and governance, but the specifics are left to state law and your own agreements. Most states, including Delaware and California, do not require a shareholder agreement, but they do set default rules for corporations and LLCs. If you do not have a written agreement, these default rules will apply, which may not match your intentions.

For example, in Delaware, shares are generally freely transferable unless restricted by agreement. In California, certain shareholder protections are built into the Corporations Code, but these may not cover all the scenarios relevant to startups. Without a written agreement, you may find yourself stuck with rules that do not fit your business or your team.

• Key functions of a shareholder agreement:
  • Defines how decisions are made, including voting rights and thresholds
  • Sets rules for selling or transferring shares
  • Protects minority shareholders from unfair treatment
  • Addresses what happens if a founder leaves, dies, or is disabled
  • Clarifies profit distribution and dividend policies
  • Outlines dispute resolution processes

Putting these rules in writing early is essential for startups, especially as you bring on new investors or team members.

What Should Founders Put in Writing Early?

Many founders are unsure what to include in a shareholder agreement, or they assume a simple template will cover everything. In reality, every business is different, and your agreement should reflect your specific needs and goals. Here are the main areas to address:

1. Share Ownership and Classes
   List all shareholders and their percentage ownership. Specify if there are different classes of shares, such as common and preferred, and what rights attach to each. For example, preferred shares may have special voting rights or liquidation preferences. If you plan to issue stock options or raise capital, clarify how new shares will be authorized and allocated.
2. Decision-Making and Voting Rights
   Spell out how decisions are made. Does each share get one vote, or do certain shareholders have extra voting power? Which decisions require a simple majority, supermajority, or unanimous consent? Examples of major decisions include issuing new shares, selling the company, approving large expenditures, or amending the agreement.
3. Founder Vesting and Departures
   Address what happens if a founder leaves, whether voluntarily or involuntarily. Will their shares vest over time, or are they earned immediately? Is there a right for the company or other shareholders to buy back their shares if they leave? For instance, a typical vesting schedule might require a founder to stay for four years to earn all their shares, with a one-year cliff. This protects the company if someone leaves early.
4. Share Transfers and Exit Rules
   Set rules for selling or transferring shares. Can shareholders sell to anyone, or do existing shareholders or the company have a right of first refusal? What happens if a shareholder dies, divorces, or becomes disabled? Some agreements include drag-along or tag-along rights to ensure minority shareholders are treated fairly in a sale.
5. Dividends and Profit Distribution
   Clarify how and when profits will be distributed. Many startups reinvest profits, but it is important to set expectations. Will dividends be paid regularly, or only if approved by the board? Are there different rules for different classes of shares?
6. Dispute Resolution
   Outline how disagreements will be resolved. Will you use mediation, arbitration, or court? Specify the governing law and jurisdiction, which is typically the state of incorporation. This can save time and money if disputes arise.
7. Other Provisions
   Consider including confidentiality clauses, non-compete or non-solicit provisions, and rules for amending the agreement. These can help protect your business and your team.

It is best to address these issues before you bring on outside investors or face a dispute. Waiting until later can make negotiations more difficult and may limit your options.

Federal and State Law: What Changes the Answer?

While the federal government does not require a shareholder agreement, it does set some baseline rules for corporations. The IRS requires companies to obtain an Employer Identification Number (EIN) and keep accurate records of ownership and governance. The SBA provides guidance on choosing a business structure and maintaining proper documentation.

Most of the rules that affect shareholder agreements are set at the state level. Each state has its own corporate statutes, often based on the Model Business Corporation Act or Delaware General Corporation Law. These laws set default rules for voting, shareholder meetings, share transfers, and more.

If you do not have a shareholder agreement, state law will fill in the gaps. For example:

• In Delaware, shares are freely transferable unless restricted by agreement. The board can generally issue new shares, but major changes may require shareholder approval.
• In California, the Corporations Code provides certain protections for minority shareholders, but does not require vesting or buyback provisions for founders.
• Some states require unanimous consent for certain major decisions, while others allow a simple majority.
• States may have different rules for resolving deadlocks or handling shareholder exits. For example, New York law allows courts to dissolve a corporation in case of deadlock, but this is a drastic remedy.

Industry-specific regulations or investor requirements can also affect what should go in your agreement. For example, a fintech startup may need to address regulatory compliance, or a venture capital investor may require special rights such as board seats or anti-dilution protection.

Your company's certificate of incorporation and bylaws may also interact with your shareholder agreement. Make sure these documents are consistent. For example, if your bylaws require a supermajority for certain actions, your shareholder agreement should not contradict this. Inconsistencies can create confusion or even legal challenges.

Finally, remember that some states have unique requirements. For example, in Texas, close corporations can opt out of certain formalities if all shareholders agree in writing. In Florida, S corporations must be careful not to violate IRS rules on eligible shareholders or classes of stock, or they risk losing S corp status. Always check the rules in your state of incorporation and consult with advisors familiar with your industry and state.

Common Mistakes in Shareholder Agreements

Even experienced founders make mistakes when drafting or reviewing shareholder agreements. Here are some of the most common pitfalls, with practical examples:

• Not putting anything in writing: Relying on verbal agreements or informal emails can lead to disputes and is hard to enforce. For example, two founders may agree to split the company 50/50, but if this is not documented, it can be difficult to prove later.
• Ignoring vesting or buyback terms: If a founder leaves early, they may keep all their shares, even if they stop contributing to the business. This can make it harder to attract new investors or motivate the remaining team.
• Unclear decision-making rules: Failing to specify how major decisions are made can create deadlocks or power struggles. For instance, if your agreement does not say how to break a tie, you could end up in a stalemate.
• No rules for selling shares: Without transfer restrictions, a shareholder could sell to an outsider, bringing in an unwanted partner. For example, a departing founder could sell their shares to a competitor if there is no right of first refusal.
• Forgetting dispute resolution: Not specifying how disputes will be handled can lead to expensive litigation. Agreeing in advance to use mediation or arbitration can save time and money.
• Not updating the agreement: As the business grows, the agreement should be reviewed and updated to reflect new investors, changes in ownership, or business pivots. For example, bringing on a new investor may require changes to voting rights or dividend policies.
• Overlooking state-specific requirements: Some states require certain provisions or filings. Failing to comply can make parts of your agreement unenforceable. For example, in some states, certain restrictions on share transfers must be noted on the stock certificate to be valid.
• Failing to coordinate with other documents: If your shareholder agreement conflicts with your bylaws or certificate of incorporation, you could face legal challenges or confusion among shareholders.

To avoid these mistakes, review your shareholder agreement with experienced advisors and update it regularly as your business changes. A professional Shareholder Agreement Review can help you spot issues before they become problems.

Checklist: What to Review in Your Shareholder Agreement

Before signing or updating a shareholder agreement, founders should review the following checklist. This helps ensure your agreement covers the most important points and reduces the risk of future disputes:

• Are all shareholders and their ownership percentages clearly listed?
• Does the agreement specify classes of shares and their rights?
• Are voting rights and decision-making processes clearly defined?
• Is there a clear process for issuing new shares or bringing in new investors?
• Are founder vesting, buyback, or repurchase terms included?
• Does the agreement set out rules for selling or transferring shares?
• Is there a right of first refusal or drag-along/tag-along rights?
• How are dividends and profit distributions handled?
• Is there a process for resolving disputes, including choice of law and venue?
• Are confidentiality and non-compete clauses included if needed?
• Is the agreement consistent with your certificate of incorporation and bylaws?
• Have you checked for any state-specific requirements or filings?
• Is there a process for amending the agreement in the future?
• Are there provisions for what happens if a shareholder dies, becomes disabled, or divorces?
• Does the agreement address what happens in the event of a deadlock?

It is also helpful to keep a record of when the agreement was last reviewed and who participated in the review. This makes it easier to update the agreement as your business evolves.

Practical Examples and State Law Caveats

To illustrate how these issues play out in practice, consider the following scenarios:

• Example 1: Founder Departure Without Vesting
  Three founders start a tech company in Delaware and split the shares equally. One founder leaves after six months to take another job. Without a vesting schedule or buyback right, the departing founder keeps one-third of the company, even though they are no longer contributing. This can make it harder to raise investment, as new investors may be reluctant to fund a company with inactive shareholders.
• Example 2: Share Transfer Without Right of First Refusal
  A California startup has four shareholders. One wants to sell their shares to an outsider. The other shareholders are surprised and unhappy, but the agreement does not include a right of first refusal. The outsider becomes a new shareholder, potentially changing the company dynamic and strategy.
• Example 3: Deadlock in Decision-Making
  Two founders each own 50 percent of a Florida corporation. They disagree on a major business decision, and the agreement does not include a deadlock resolution mechanism. Florida law allows for judicial dissolution in case of deadlock, but this is expensive and may result in the company being shut down.
• Example 4: State-Specific Filing Requirements
  A Texas close corporation wants to restrict share transfers. Texas law requires that these restrictions be included in the certificate of formation and noted on the stock certificates. If the company fails to do this, the restrictions may not be enforceable against third parties.

These examples show why it is important to tailor your shareholder agreement to your specific situation and state law. What works in one state or industry may not work in another.

For founders in regulated industries, such as healthcare or financial services, additional rules may apply. For example, certain investors may be prohibited by law from owning shares, or you may need to include special compliance provisions. Always check with advisors who understand your industry and state.

FAQs

Is a shareholder agreement legally required in the US?

No, a shareholder agreement is not legally required at the federal level or in most states. However, it is highly recommended for any business with more than one shareholder. Without one, state law and your company's bylaws will set the default rules, which may not reflect your intentions or protect your interests.

What is the difference between a shareholder agreement and bylaws?

Bylaws are a public document filed with the state that sets out the basic rules for running the company, such as how meetings are held and how directors are elected. A shareholder agreement is a private contract between shareholders that can address more detailed or sensitive issues, such as share transfers, founder departures, or dispute resolution. Bylaws are generally required by state law, while shareholder agreements are optional but highly recommended.

Can a shareholder agreement override state law?

In many cases, a shareholder agreement can set rules that override the default provisions of state law, as long as those rules are not prohibited by statute. However, some state laws set mandatory requirements that cannot be waived, such as certain voting rights, notice requirements, or shareholder protections. Always check the laws of your state of incorporation before finalizing your agreement to ensure your provisions are enforceable.

What happens if a founder leaves and there is no agreement?

If there is no shareholder agreement or vesting schedule, a departing founder may keep all their shares, even if they stop working for the company. This can create problems for the remaining founders and make it harder to raise investment. Including clear terms for founder departures in your agreement can help avoid these issues and provide a fair process for all parties.

How often should a shareholder agreement be reviewed or updated?

It is a good idea to review your shareholder agreement at least once a year, or whenever there is a major change in ownership, investment, or business direction. Regular reviews help ensure the agreement stays relevant and enforceable as your company grows and changes. Major events that should trigger a review include bringing on new investors, changing the company structure, or expanding into new states or industries.

Key Takeaways

• A shareholder agreement is not legally required but is strongly recommended for startups and small businesses with more than one owner.
• Putting key terms in writing early can prevent disputes, protect founder interests, and clarify decision-making.
• Federal rules set baseline requirements for company records, but most shareholder agreement rules are set by state law and your own contract terms.
• Common mistakes include skipping vesting, unclear voting rules, failing to update the agreement, and not coordinating with other documents.
• Use a checklist to review your agreement and consult with experienced advisors to tailor it to your business and state requirements.
• State law and industry regulations can affect what should be included in your agreement, so always check for unique requirements in your state or sector.

If you are a founder or operator looking to review or update your shareholder agreement, our team can help you understand your options and avoid common pitfalls. For practical guidance, contact us at (888) 449-8437 or team@sprintlaw.com. Where legal services are required, they are delivered by licensed lawyers at trusted US law firms through the Sprintlaw platform.