101’s on SHAs
By Faith Sing and Kelvin Ho
This article was originally published on 24 November 2020 on Biotech Connection Singapore’s website. While it refers to a biotech context, it has a broader application for all “just-born” businesses thinking about a shareholders’ agreement.
Spinning out a biotech company from a university, research institute or hospital is likely to involve different decisions to that scientists are used to making.
It is likely to first involve fundamental “go or no go” issues such as ensuring that the invention has a future as a business, refining the business model and developing a more granular business plan. If there is a potentially viable business model, you may be looking to enter into collaborations and raise funds to grow and operate the business.
In addition, you may need to take a number of “legal related” steps which are also important to develop the business, such as:
1. setting up the company and putting in place arrangements for its smooth running,
2. entering into a license agreement or an assignment of the intellectual property rights that protect the technology, and
3. setting up various agreements with stakeholders and collaborators to take the next steps in the development of the technology.
Founders will often drive these steps, with help from commercialization offices, mentors and advisers. Often these steps are not taken in a neat sequence and founders may find themselves working on all of them at once.
This article gives a brief introduction to a key agreement you may want to put in place in parallel with establishing the company – the shareholders’ agreement.
So, what is a shareholders’ agreement?
A shareholders’ agreement is, as the name suggests, an agreement between the shareholders of the biotech start-up company to regulate their rights and obligations in relation to their shareholding and the company.
Why do shareholders enter into a shareholders’ agreement?
Shareholders enter into shareholders’ agreements to ensure that all of them have clear expectations on key matters such as:
- how decisions about the business will be made,
- how the business might grow,
- how new shareholders may be introduced, and
- how shareholders might exit the business.
If shareholders do not enter into a shareholders’ agreement, the company’s constitution and general law will be more important in determining the outcome of disputes on these key areas. There is likely to be greater uncertainty for shareholders.
It is a good idea to think more carefully before relying on general law, because general law:
- does not deal with all areas which shareholders may have views on or which others in similar situations have come to have disagreements over,
- shareholders may want to agree on outcomes different to that provided by general law.
For example, general law and template constitutions might provide that a director is appointed if more than 50% of the votes entitled to be cast at a general meeting are cast in his or her favor.
However, a group of four shareholders each holding 25% of the shares may decide that each of them should be entitled to have one director of their choosing appointed. Instead of leaving this to the goodwill of the others each time the topic comes up, the four shareholders may enter into an agreement to formalize their understanding.
General law is still relevant to the rights and obligations of shareholders even if they enter into a shareholders’ agreement. However, its application is, in many cases, modified and shareholders have greater certainty.
To understand this better, it is best to look at the areas that a shareholders’ agreement covers as it gives an idea of what shareholders in similar situations might have agreed between them.
What goes into a shareholders’ agreement?
Shareholders’ agreements do vary, sometimes dramatically, but to give an idea of the types of issues that shareholders’ agreements deal with, here is a summary of what goes into it taking the example of the shareholders’ agreement that is part of the Venture Investment Model Agreement or VIMA Kit.
The VIMA Kit is a suite of documents launched by the Singapore Academy of Law and the Singapore Venture Capital Association in an effort to standardize documentation for use in seed rounds and early stage financings. It includes a shareholders’ agreement and other documents you might see in a fundraising.
The shareholders’ agreement in the VIMA Kit deals with issues such as:
- How many directors make up the board of directors and who may nominate and appoint directors to the board.
- What type of information must be given to particular shareholders and how often such information is given.
- What voting or approval thresholds are required for key proposed actions of the company such as issue of shares, change of the constitution or winding up of the company.
- What rights certain investors have to precipitate or participate in a sale or initial public offering of the company.
- What rights certain shareholders have to subscribe for shares if there is a further issue of shares in the company.
- What restrictions there are on certain shareholders so that they do not transfer their shares or only do so after a particular offer process.
- Any right of shareholders to sell their shares if others plan to sell their shares.
- Any obligation on shareholders to sell their shares if others plan to sell their shares.
- Any non-compete obligations on key shareholders.
- Confidentiality obligations on shareholders and the company.
Remember though that the VIMA Kit is only a starting point for an investment round and every shareholders’ agreement should reflect the preferred positions and agreed arrangements negotiated between you, other shareholders and investors.
A biotech start-up may not be at a stage where the VIMA Kit terms and conditions are more relevant, for example, the Series A investment stage. Even if it is, your investors may ask for very different outcomes to that in the VIMA Kit or you may not find the VIMA Kit shareholders’ agreement as founder friendly as you would prefer.
Are all shareholders’ agreements the same?
Shareholders’ agreements are never the same even if they deal with similar topics.
Although there are many template or model agreements available, if you review and compare a few of them, you will notice differences. When you customize a template or model agreement, you must be careful not to become hostage to someone else’s negotiated outcome and should approach it with a critical mind.
Differences may arise from a variety of factors such as:
- whether the company has a “just born” business or it has been operating for a while and has valuable assets,
- who the investors and key shareholders are, what their negotiation leverage and temperaments are and whether this is an early investment or a later one,
- whether the shareholding of the company is diffused amongst a large group of founders and investors or the company has a smaller group of major shareholders.
How do I decide what to put into my shareholders’ agreement?
Your task in concluding a shareholders’ agreement for your biotech spin-out is to:
1. really understand why certain provisions are suggested for inclusion in your shareholders’ agreement. By doing this, you will likely learn a lot more about company structures and finance than you might know now. It is better to be informed than to inadvertently give away a key right by not understanding and assuming provisions are “standard”.
2. make an informed decision about what you, as a shareholder, would like to see in your shareholders’ agreement, with one eye on market practice. In practical terms, that can be achieved by working with a lawyer who has helped similar stage companies. Conversations with other founders, mentors and advisors can also be useful.
3. negotiate a compromise that works for all shareholders and that will allow the business to operate, develop and grow.
You should not underestimate the amount of time and effort you and other shareholders will need to invest in order to understand and negotiate a final agreement and this might inform what you ask for in your first proposal. An experienced lawyer can help you achieve this more quickly and with a better result.
When should I create a shareholders’ agreement?
Ideally, you should enter into a shareholders’ agreement at the time your company is incorporated and shares are issued to its first group of shareholders.
Practically, it may be that the company is incorporated quickly with just one shareholder and director. Subsequently, founders may decide to invest time and effort into a full shareholders’ agreement only when arrangements for the business start to fall into place – that is, when there is something to lose. Some founders may decide to start with an abbreviated version of the shareholders’ agreement or a founders’ agreement and to “upsize” as part of a funding round.
Of course, the clearer your arrangements between the shareholders from the start, the fewer disputes you are likely to have. However, for many new businesses, it is important to balance and devote resources between:
- protecting the business and getting its legal foundations right for growth; and
- building a business worth protecting.
You should also expect that, as part of a series of funding rounds, it is likely that your shareholders’ agreement will evolve to cater to the requirements of different investors and a different mix of shareholders.
In summary, a shareholders’ agreement is one of the first few key documents which a newly established biotech company would typically put in place. It serves an important function of setting out clear expectations on key matters concerning the company. As explored in this article, no two shareholders’ agreement are identical and stakeholders should pay close attention in deciding what it should encompass even when using template documents.
Shareholders’ agreements can contain reasonably complex concepts that you may want to review a few times. They are not always accessible, possibly because business and shareholder relationships are not always straightforward.
Read more on shareholders’ agreements (SHA):
- transfer of shares provisions – 5 key concepts on transferring shares under a SHA
- board control provisions – 5 key options for board provisions in a SHA
- pre-emptives on transfers – 5 key options for pre-emptives on transfers in a SHA
- drag along rights – 5 key points on drag-along rights in a SHA
- reserved matters – 5 key considerations for a reserved matters list in a SHA
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