The excitement of launching a new business can often overshadow the importance of thorough, structured discussions between business partners.
However, open and honest conversations are crucial for ensuring the long-term success of the venture.
It is common, and in fact, essential for business partners to hold multiple meetings when starting a business to discuss their plans. These discussions help align expectations, define roles, mitigate risks, and establish a shared vision. Without this foundational work, even the most promising business ideas can falter.
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In practice, while many business relationships begin with productive discussions, these agreements are often not properly memorialized in writing — or if they are, not in a legally binding format that could resolve disputes down the road. As a result, one of the most important documents for business partners to have is a Shareholders Agreement.
Although it might not seem as urgent as drafting a business plan or securing funding, this document can prevent numerous conflicts and complications later. A Shareholders Agreement is a written contract among the shareholders or partners of a company. While it typically involves all shareholders, there are situations where only some shareholders enter into this agreement. Its primary purpose is to protect the rights and investments of the shareholders.
It’s also important to note that a Shareholders Agreement is distinct from the Articles of Incorporation and Bylaws of a corporation. While there may be some overlap in provisions, these documents are not the same.
- The Articles of Incorporation and Bylaws are public documents required by law for the establishment of a corporation. These documents set out the basic framework for the company’s operations, including shareholder ownership, the composition of the board of directors, officers’ duties, meeting protocols, and limitations on the transfer or sale of shares.
In contrast, a Shareholders Agreement is a private contract between shareholders. It provides more detailed, specific provisions that supplement the Articles of Incorporation and Bylaws, addressing matters not covered by these public documents. - Since Articles of Incorporation and By-laws are public documents, these are accessible by the public from the Securities and Exchange Commission.
On the other hand, Shareholders Agreements, being private contracts, are not generally accessible and available to parties that are not party to the agreement given this document the advantage of confidentiality.
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Having a Shareholders Agreement in place is particularly advantageous when there are minority shareholders because without this agreement, these shareholders will generally be on their own with little control or say in the running of the corporation with the majority shareholders having the right to make decisions for and on behalf of all the shareholders.
Below are some provisions shareholders may consider incorporating in their Shareholders Agreements.
1. Transfer of Shares and Ownership
Right of First Refusal
The choice of business partners is a personal one and most people will only agree to go into business with people they know, trust or like. To prevent outsiders from becoming shareholders of a corporation, some corporations have in place the Right of First Refusal.
Generally, this right provides that any shareholder that wishes to sell its shares of stock in the corporation must offer to sell it to the existing shareholders for the same terms and conditions that the selling shareholder is offering it for sale to others. Only when the existing shareholders decline to exercise their Right of First Refusal is the selling shareholder allowed to sell its shares to outside parties.
Right to Purchase at Book Value
In some cases, the shareholders may agree to a Right of First Refusal, which requires the selling shareholder to offer their shares first to the existing shareholders. If the existing shareholders choose to exercise this right, they may purchase the shares at book value, rather than having to match the price offered by an outside buyer.”
Tag Along Right
Tag-along right is a provision mainly used to protect minority shareholders. When the majority shareholder decides to sell its shares, the tag-along right gives the minority shareholders the right to sell their shares with the majority shareholder and the buyer must purchase the shares together at the same time for the same price.
This right prevents the minority shareholders from being left behind and stuck with the new majority shareholders who may have a different direction and vision for the company than what the original shareholders had in mind.
Notably, the Tag-Along Right is not limited to when the selling shareholder owns the majority of the shares of the corporation as shareholders can agree that the Tag-Along Rights apply to every sale of shares of stock.
Drag Along Right
There is also the Drag-Along Right which enables the selling shareholder, who may be the majority shareholder, to force the other shareholders to sell their shares at the same time for the same price and terms to the buyer.
This right is sometimes included in Shareholders Agreements to guarantee to any buyer that it will be able to acquire 100% of the company considering that some buyers do not want to have to deal with minority shareholders or simply want complete control of the corporation.
To be continued …
(The author, Atty. John Philip C. Siao, is a practicing lawyer and founding Partner of Tiongco Siao Bello & Associates Law Offices, an Arbitrator of the Construction Industry Arbitration Commission of the Philippines, and teaches law at the De La Salle University Tañada-Diokno School of Law. He may be contacted at jcs@tiongcosiaobellolaw.com. The views expressed in this article belong to the author alone.)