How a Shareholders’ Agreement Can Safeguard Your Startup

Starting a business with family or friends can seem like an exciting opportunity, driven by trust, shared values, and common goals. However, many entrepreneurs soon discover that personal relationships can complicate business dynamics. What starts as a promising venture can quickly unravel due to misunderstandings, differing expectations, or conflicting visions. This lack of alignment can lead to disputes, tension, and even the eventual dissolution of the business.

One of the most effective ways to prevent such issues and ensure clarity is by having a well-drafted Shareholders’ Agreement in place. While it may seem unnecessary at first, a Shareholders’ Agreement is a critical tool that outlines the rights, responsibilities, and obligations of all shareholders. For startups, especially those involving family and friends, this agreement serves as a strategic safeguard to avoid misunderstandings, provide a framework for resolving disputes, and ensure the long-term stability of the business.

Understanding why a Shareholders’ Agreement is so important is crucial because a Shareholders’ Agreement is a legally binding contract made between the shareholders of a company where it may be individual or company entities who own the shares of the company. It outlines the rights, responsibilities, and obligations of each shareholder, and governs a good relationship on how the business should be run, how decisions should be made, and how conflicts should be resolved internally.

Shareholders’ Agreement is different from the company’s constitution. It is usually kept private between the parties involved. While the Articles are publicly accessible, the shareholders’ agreement offers a more personalized level of protection and flexibility for all shareholders.

The difference between a Shareholders’ Agreement and a Company Constitution lies in their confidentiality and accessibility as a Shareholders’ Agreement is a private and confidential document that is not required to be filed with any authorities and is accessible only to the parties involved.

In contrast, a Company Constitution is a public document filed with the Companies Commission of Malaysia (SSM), and anyone can request a copy.

A Shareholders’ Agreement typically covers more personal and financial matters between shareholders, such as exit strategies (e.g., sale of shares, right of first refusal), dividend policies, funding obligations, non-compete clauses, and dispute resolution mechanisms.

On the other hand, a Company Constitution deals mainly with structural and procedural matters, such as appointment and removal of directors, issuance of shares, quorum for meetings, and voting rights.

In terms of flexibility, a Shareholders’ Agreement is more adaptable and can be amended by mutual agreement among the parties.

The Company Constitution, however, is more rigid and requires a special resolution to make any amendments.

Regarding enforceability, a Shareholders’ Agreement is enforced as a contract under general contract law and is binding only on the parties who signed it. Meanwhile, the Company Constitution is binding on the company, its members, and directors under the Companies Act 2016.

The constitution acts as the guideline for how the company operates, and the Shareholders’ Agreement as the understanding between the shareholders. Both are important and can coexist—but while the Constitution is mandatory for every company, a Shareholders’ Agreement is optional but highly recommended, especially for startups with multiple shareholders.

On clarifying roles and responsibilities, startups often begin with informal understandings among founders. As the business grows, ambiguity in roles can lead to conflict. A Shareholders’ Agreement defines each shareholder’s role in the company, their level of involvement, decision-making powers, and what happens if expectations are not met.

Protecting Minority Shareholders is crucial for any startup. Minority shareholders often have little control over company decisions. An agreement can include minority protection clauses, such as requiring unanimous consent for major decisions or giving minority shareholders a right of first refusal if new shares are issued or selling their shares.

Preventing Unwanted Share Transfers is essential for startups to maintain control, as the last thing a founder wants is to suddenly be in business with a new shareholder. A Shareholders’ Agreement can control the transfer of shares through pre-emption rights, tag-along and drag-along clauses, and restrictions on selling shares to third parties without prior approval.

Setting Out Exit Strategies is important for startups to plan ahead, because eventually some shareholders will want to exit—whether through selling their shares, leaving the company, or in the event of a merger or acquisition. A Shareholders’ Agreement outlines how exits are to be handled, providing a clear and fair path forward while protecting the company from instability.

Handling Disputes and Deadlocks is key for startups to stay operational, as disagreements are inevitable, even among the closest of partners. Including dispute resolution mechanisms—such as mediation, arbitration, or even buy-out provisions—ensures conflicts are resolved efficiently without derailing the business. The Auspicious Journey Sdn Bhd v Ebony Ritz Sdn Bhd [2022] Federal Court case underscores the judiciary’s commitment to upholding contractual dispute resolution mechanisms. It is a crucial reminder for businesses to craft clear and enforceable shareholders’ agreements. It helps to ensure that arbitration or other chosen dispute resolution methods remain intact even when tensions arise between stakeholders.

Defining Shareholding and Capital Contributions is vital for startups to avoid misunderstandings, because the agreement should specify how much capital each shareholder is contributing, how much the shareholding for each shareholder and what happens in future funding rounds. This helps avoid misunderstandings about ownership percentages and protects early investors from unexpected dilution.

Dividend Distribution Policy is important for startups to balance growth and returns, as the company adopts a prudent dividend policy aimed at balancing sustainable growth and shareholder returns. In the early stages, the Company intends to retain the majority of its earnings to support business expansion, product development, and operational needs. Dividends, if any, will be considered only after meeting essential capital requirements and ensuring sufficient reserves for future growth. Any distribution of dividends will be at the discretion of the Board of Directors, subject to the availability of profits and compliance with applicable laws. This approach ensures the Company remains financially healthy while progressively building long-term value for its shareholders.

In conclusion , A Shareholders’ Agreement is a foundational tool that every startup should implement from the outset. It provides clarity, structure, and security that allows founders and investors to focus on growth without worrying about internal disruption.

As your startup evolves, your Shareholders’ Agreement should be updated from time to time. Regularly reviewing and updating the document ensures it remains relevant to your company’s goals and protects all parties involved.

In the fast-paced world of startups, a solid legal foundation can be the key factor that determines success or failure.

Key Clauses to Include are important because while every Shareholders’ Agreement is different depending on the nature and goals of the business, there are some commonly included clauses that startups should consider. These include board composition and voting rights, rights of first refusal and pre-emption rights, drag-along and tag-along rights, dividend distribution policy, non-compete and confidentiality obligations, deadlock resolution mechanism, and exit provisions, such as buy-sell clauses, IPO, or M&A.

It is crucial to ensure that the terms of an agreement—particularly those relating to the operational mechanism, management structure, and policy framework—are drafted with clarity and precision. This is in line with Section 30 of the Contracts Act 1950, which provides that:

“Agreements, the meaning of which is not certain, or capable of being made certain, are void.”

In other words, any contractual provision that is vague, ambiguous, or incapable of being made certain may render the entire agreement, or that particular clause, legally unenforceable. Therefore, parties must take care to ensure that all material terms are clearly defined and leave no room for ambiguity. This helps to avoid disputes and ensures the enforceability of the agreement under Malaysian contract law.