Shareholders' agreement in startups: handy governance tool, but not without borders

For startups and scale-ups, a shareholders' agreement is often one of the most important documents besides the articles of association. That makes sense. In young growth companies, founders, investors and sometimes management shareholders want to make additional agreements about cooperation, control, information, financing and exit.

At Startup-Recht, we regularly see that this agreement is primarily approached as a practical deal document. That is partly true, but legally it is more nuanced. A shareholders' agreement offers a lot of space, but not unlimited. Moreover, not everything that is contractually agreed upon is automatically enforceable in the way that the parties have in mind.

In this blog, we list the most important points of attention.

What exactly is a shareholders' agreement?

A shareholders' agreement is an agreement in which shareholders further regulate their mutual legal relationship, additional to or different from the articles of association. A voting agreement is often also part of this. In doing so, shareholders agree how they will exercise their voting rights in certain cases.

This is familiar to startups. In the early phase, relationships are often still strongly determined by personal cooperation between founders. As soon as external investors step in, the need for clarity grows. Who can nominate a director? Which decisions require additional coordination? What happens when shareholders are no longer on the same page? And how do you prevent a 50/50 ratio from getting stuck?

A shareholders' agreement is precisely intended to structure these types of points contractually.

The company can be a party to this, but that is not always necessary. That difference may become relevant later, for example when a discussion arises about the extent to which agreements also work within the company.

Why do the parties opt for a shareholders' agreement?

The strength of a shareholders' agreement lies in its flexibility. In it, parties can make agreements on various topics, such as:

• the financing of the company
• dividend policy
• the composition of the board and supervisory board
• provision of information
• mandatory offering of shares in certain situations
• exercising voting rights

For startups and scale-ups, the latter is particularly relevant. Many companies depend on a workable governance structure. A voting agreement can then help prevent impasses, for example in a joint venture or at a company with two equal shareholders. An agreement can also be used to properly organize blocking, for example by agreeing that shareholders first consult each other and then vote according to that outcome in the general meeting.

This makes the shareholders' agreement attractive for companies where speed, investability and mutual alignment are crucial.

Are shareholders' agreements always allowed?

In principle, yes. In principle, voting agreements between shareholders are also allowed. The starting point is that a shareholder can use his voting right to represent his own interests and can therefore also contractually bind himself thereto.

In practice, this is an important starting point. It means that shareholders are not only allowed to make separate commercial agreements, but also agreements about how they work together and prepare decisions within the company.

However, that is not a license. For each shareholders' agreement, it must always be assessed whether the concrete agreements are legally valid. The agreement has its limits in law, morals and public order. So that's where the first nuance starts: the fact that shareholders are allowed to agree on a lot does not mean that every governance agreement is legally sustainable.

What are the limits of the shareholders' agreement?

The most important limit is that a shareholders' agreement must not be aimed at bringing about legal acts or decisions that are contrary to the law, good morals or public order.

In addition, a second layer plays. Even if an agreement does not conflict head-on with an explicit legal ban, it can still be problematic if the exercise of voting rights based on that agreement conflicts with legal standards of care, such as fairness and fairness.

This is an essential point for founders and investors. In the deal phase, it sometimes seems attractive to close everything. But the tighter the agreement, the greater the chance that it will come under pressure in a conflict situation. Especially when the agreement actually works towards a decision that is unreasonable or disrupts relations within the company in an unacceptable way.

Freedom of contract is broad, but not unlimited

A relevant practical insight is that company law does not automatically block every contractual deviation. The fact that shareholders contractually agree on something that is not in the statutes, or even differs from the statutory regulation, therefore does not necessarily mean that that agreement is invalid.

At the same time, it must always be considered on a case-by-case basis whether the appointment is permissible. It is precisely that casuistic character that makes careful editing so important. A provision that seems logical on paper may turn out differently in a concrete dispute than the parties previously thought.

Voting and similar structures

It becomes more exciting when it comes to agreements about voting behavior. The literature has argued that the sale of voting rights is illegal because a shareholder then makes his voting right an independent source of income. On the other hand, it is also assumed that not every consideration for a voting appointment is fundamentally difficult. Once again, the decisive factor is whether the concrete agreement is legally valid, also considering its content, duration, the other party and the subject matter being voted on.

For startup practice, this mainly means that parties must be careful with agreements that seem economically smart, but will legally be too much like making control separately tradable.

Permanent voting

Another sensitive theme is permanent voting, i.e. the situation where a shareholder commits himself in a general way to vote for a longer period of time according to someone else's instructions.

Such an agreement is not necessarily invalid, but admissibility depends very much on all the circumstances of the case. Relevant may include: the nature of the obligation, the purpose of the agreement, the role of the instructor, the option to terminate, the severity of a penalty clause and the shareholder's involvement in the company.

For startups, this is relevant in investment structures where one party wants to organize actual control over decision-making for a long time. The further the agreement moves from coordination to the structural elimination of independent judgment, the greater the risk.

Voting on instructions from directors or supervisory directors

A clear limit lies in agreements that oblige shareholders to vote in accordance with instructions from directors or supervisory directors. Such agreements are illegal because they detract too much from the dual structure of the company and upset the balance between the bodies.

This is an important point of attention in founder-led companies, where governance and shareholding are often close together. This is where governance agreements can quickly mix with operational management. Legally, however, it remains important to keep the roles clean.

Shareholders' agreement or statutes: what do you arrange where?

This is a question that comes up in almost every investment round. Many issues can be included in both the articles of association and in a shareholders' agreement. Examples include transfer restrictions, quorum requirements, majority requirements or the suspension of shareholders' rights.

However, statutes and shareholders' agreements are not interchangeable.

Statutes are primarily governed by company law. The shareholders' agreement falls primarily under contract law. This has practical consequences.

In principle, a shareholders' agreement only binds the parties that have concluded it. Statutes also apply to others. Furthermore, statutes can be amended by a resolution of the general meeting, while changing a shareholders' agreement in principle requires the consent of all contracting parties.

For many startups, confidentiality is a decisive reason not to include agreements in the statutes. Statutes are public, while the content of a shareholders' agreement is in principle not known to third parties. That is also why commercial and governance agreements are often developed contractually.

On the other hand, certain statutory regulations have property law effect, while comparable contractual arrangements do not. In addition, the way in which both documents are explained differs. In a shareholders' agreement, not only the text counts, but also what parties could reasonably expect from each other. This makes context and negotiation history potentially relevant.

Can you have statutes refer to the shareholders' agreement?

A reference in the articles of association to a shareholders' agreement is possible on its own. What is not possible is to use such a reference to automatically give the content of that agreement the same corporate status as a statutory provision.

In other words: you cannot “incorporate” a shareholders' agreement into the statutes in a roundabout way as if it were an integral part of it. That route is not allowed.

The idea behind this is practical and logical. Prospective shareholders should not automatically be bound by regulations that are not included in the statutes themselves and are therefore not known.

For startup practice, this means that a smart combination of statutes and shareholders' agreements often works better than looking for hybrid structures. The statutes regulate the corporate law basis. The shareholders' agreement supplements that basis with contractual agreements. The two should be linked, but remain legally different instruments.

Does a shareholders' agreement only work contractually, or also within the company?

The starting point is clear: violation of a shareholders' agreement is, in principle, a breach of contract. But that does not automatically mean that a vote cast in violation of that agreement is invalid. The shareholder retains control over his vote in the general meeting, even if he had contractually promised otherwise.

This is a surprising point for many entrepreneurs. On paper, a voting appointment may seem very harsh, but in company, the vote cast can still be valid.

That's not the end of the story. Indeed, under certain circumstances, a shareholders' agreement can have a corporate effect.

What is corporate pass-through?

Corporate impact means that violation of the shareholders' agreement not only has contractual consequences between the parties, but also becomes relevant within the company. The company and its organs must then account for that agreement.

The legal basis for this often lies in open standards, such as fairness and fairness, tort or improper performance of duties. In doing so, the case law depends heavily on the circumstances of the case.

The best-known form of effect is that a decision made in violation of a shareholders' agreement can be annulled for breach of fairness and fairness. In addition, non-compliance in an investigation process can contribute to the opinion that there is doubt about a correct policy, or even that there is mismanagement.

This is a crucial point for startups and scale-ups. Anyone who thinks that a shareholders' agreement is “just a contract” underestimates its impact. In conflict situations, this agreement can indeed have an impact on the assessment of decision-making and governance.

Does the company have to be a party?

There is disagreement about whether corporate impact is only possible if the company is a party to the shareholders' agreement. So there is no simple yes or no that applies in all cases.

In practical terms, this means that it is wise to think consciously about the company's position beforehand. Do only shareholders have to be parties, or is it desirable in this structure that the company also signs? This can be particularly relevant when the agreement contains agreements that affect the functioning of the board or other bodies.

What if not all shareholders are parties?

Even then, it gets more complicated. Implementation is not necessarily out of the question, but restraint is obvious. Especially when shareholders who are not parties are affected by invoking agreements in which they do not participate, this can be met with resistance.

For growth companies with different levels of shareholders, such as founders, angel investors, seed investors and later venture capital, this is a serious point of attention. The larger and more mixed the cap table, the more important it becomes to properly organize who exactly is tied and how new shareholders join the contractual regime.

How do you enforce compliance with a shareholders' agreement?

Because a vote cast in violation of the agreement remains in principle valid, enforcement often involves means of obligations.

For example, a claim for compliance or compensation. In addition, a penalty clause can be included to financially enforce compliance. A chain clause is also important in practice, precisely to prevent obligations from disappearing as soon as shares are transferred.

In addition, an injunction or ban can be requested in summary proceedings, for example to enforce compliance with a voting appointment or to stop certain voting behavior. However, we also work with an irrevocable power of attorney to support compliance with voting agreements. In addition, such a proxy does not completely sideline the shareholder: in principle, he can still appear and vote at the meeting himself.

Another practical tool is the statutory quality requirement. For example, the articles of association may require that a shareholder is a party to a shareholders' agreement. Violation may be subject to sanctions, such as suspension of shareholders' rights.

For startups, this is often an effective way to better embed governance agreements. At the same time, here too, careful consideration must be given to which sanctions are and are not admissible.

What if compliance with the agreement itself becomes problematic?

In principle, a shareholder remains contractually bound by his voting obligations. However, situations can arise where compliance with that contractual obligation would actually mean that the shareholder is acting in violation of his corporate law obligations.

Then, under special circumstances, according to standards of fairness and fairness, it may be unacceptable to hold the shareholder to comply with his contractual voting obligation.

This is an important safety valve. In practice, this means that a shareholders' agreement can never be completely separated from the corporate context. Contractual toughness finds its limit where compliance would lead to unsustainable corporate law outcomes.

What does this mean in concrete terms for startups and scale-ups?

The most important lesson is that a shareholders' agreement is not a standard annex to an investment, but an essential part of the company's governance.

For startups and scale-ups, these concerns are particularly relevant:

First, think carefully about the relationship between statutes and shareholders' agreement beforehand. Not everything has to be in the statutes, but both documents must be linked.

Second, be precise in voting appointments. An appointment that is intended to calm down can actually trigger discussion later if it is not clear how far the bond extends, how long it lasts and what happens in the event of conflicts.

Third, pay attention to the composition of the cap table. The more different shareholders are involved, the more important it is to properly arrange entry, affiliation and transfer.

Fourthly, do not underestimate the impact of corporate collaboration. A shareholders' agreement does not automatically work as a statute, but in practice it can have consequences for the validity of decisions and the assessment of policy.

Fifth, build enforcement carefully. A penalty clause, chain clause, quality requirement or summary procedure can make a lot of difference, but only if those instruments are well thought out.

Conclusion

A shareholders' agreement is a powerful tool for startups and scale-ups to sharply regulate cooperation, control and decision-making. That is precisely why it is important to look beyond the commercial deal points alone.

The space to make appointments is large, but not unlimited. The legality of concrete provisions, the relationship with the statutes, the possibility of corporate effect and the enforceability of voting agreements deserve serious attention.

At Startup Law, we often see that the real difference is not in having a shareholders' agreement, but in its quality. A good document does not prevent every conflict, but it does empower the company as soon as interests shift.

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