When several people start a Norwegian limited liability company together, it is easy to focus mainly on getting the company registered, opening a bank account and starting the business.
That is natural. But for many companies, the difficult questions arise later: What happens if one shareholder wants to sell? What if one person works much more than the others? What if the shareholders disagree on strategy, dividends or future financing? And what happens if a shareholder dies, becomes ill or stops contributing?
The articles of association and the Norwegian Private Limited Liability Companies Act provide a framework, but they do not solve everything. That is why many shareholders enter into a shareholders’ agreement.
What is a shareholders’ agreement?
A shareholders’ agreement is an agreement between two or more shareholders in a company. It regulates how the shareholders are to act towards each other, and how they are to exercise their rights as owners.
Shareholders’ agreements are commonly used to regulate:
- who should sit on the board,
- how the shareholders should vote at general meetings,
- when shares may be sold,
- whether the other shareholders should have pre-emption rights,
- what happens if a shareholder leaves the company,
- how disputes should be resolved,
- whether shareholders have a duty to work for the company,
- how the company should be financed,
- when dividends may be distributed,
- what happens if a shareholder dies, becomes ill or goes bankrupt.
A shareholders’ agreement is particularly useful in small and medium-sized companies with few owners, where cooperation between the shareholders is important for the company’s business.
Why are the articles of association not always enough?
All Norwegian limited liability companies must have articles of association. The articles are the company’s basic rules and are registered in the Norwegian Register of Business Enterprises. They must state, among other things, the company name, business purpose, share capital and nominal value of the shares.
But the articles are often short and general. They are not always suitable for regulating more detailed matters between the shareholders.
A shareholders’ agreement can be more flexible. It can include practical and commercial provisions that the parties do not necessarily want to make public through the articles of association.
Example: The articles may state that shares can only be transferred with the consent of the board. The shareholders’ agreement can regulate in more detail how the price is to be determined, who has the right to buy, how quickly settlement must take place, and what happens if the parties disagree on valuation.
A shareholders’ agreement normally only binds the parties
An important starting point is that a shareholders’ agreement normally only binds those who have entered into it.
This means that the agreement does not, as a general rule, bind the company, the board, the general manager or new shareholders, unless there is a separate legal basis for this.
This is an important difference between articles of association and shareholders’ agreements:
- The articles of association regulate the company’s legal framework and have corporate law effect.
- The shareholders’ agreement is a private law agreement between the shareholders.
If a shareholder votes in breach of the shareholders’ agreement at a general meeting, the general meeting resolution will normally still be valid. The shareholder may have breached the agreement towards the other shareholders, but the corporate resolution is normally not invalid for that reason alone.
This is why it is often important to think carefully about what should be included in the articles of association, and what should instead be included in the shareholders’ agreement.
Shareholders’ agreements are interpreted according to their wording
In Rt. 1994 p. 581, the Norwegian Supreme Court considered a dispute concerning the interpretation of a shareholders’ agreement. The question was whether an agreement concerning an obligation to purchase shares could be interpreted broadly, so that it also covered a situation that did not clearly follow from the wording.
The Supreme Court held that the agreement had to be interpreted according to its wording. It could not be given an extended, purpose-based interpretation.
The judgment is practically important because it shows that shareholders’ agreements should be drafted precisely. If the parties want a provision to apply in specific situations, this should be clearly stated in the agreement.
It is risky to assume that “everyone understands what we meant”. In a later dispute, courts will often place significant weight on what the agreement actually says, especially where the agreement was entered into by professional or commercial parties.
What should a shareholders’ agreement include?
The content of a shareholders’ agreement should be adapted to the company and the shareholders. An agreement between two founders in a startup should not necessarily look like an agreement between investors in a mature company.
Still, there are several topics that should often be considered.
1. Ownership and shares
The agreement should state who owns shares in the company, the ownership percentage of each shareholder, and whether there are different share classes.
In small companies, this is often simple. Even so, it can be useful to describe the ownership structure clearly, especially if the shareholders have different roles or have contributed different types of value.
Example: One shareholder contributes capital, while another contributes work, technology or customer relationships. The agreement should then explain how the parties have assessed this, and which rights and obligations follow from the ownership interests.
2. Board composition
The shareholders’ agreement can regulate who has the right to nominate or elect board members.
This is particularly important where one shareholder does not have a majority alone, but should still have a right to board representation. It may also be relevant where investors require a board seat as a condition for investing.
Example:
- The founders have the right to appoint one board member.
- The investor has the right to appoint one board member.
- The chair of the board is to be elected jointly.
The board election itself formally takes place at the general meeting. The shareholders’ agreement can nevertheless oblige the parties to vote in a certain way.
3. Voting at the general meeting
Shareholders may agree how they are to vote in specific matters.
This may be useful for decisions concerning:
- share capital increases,
- sale of the business,
- major loans,
- amendments to the articles of association,
- mergers or demergers,
- dividends,
- election of the board,
- liquidation of the company.
Such provisions can create predictability. At the same time, they should not be too rigid. The company may develop, and the parties’ needs may change.
4. Work obligations and expected contribution
In many startups, capital is not the only important contribution. The company is often built on the shareholders themselves working in the business.
The shareholders’ agreement should then regulate what is expected.
Example:
- Must all founders work full-time?
- Can a shareholder have another job on the side?
- What happens if one shareholder stops contributing?
- Should work be compensated through salary, shares or both?
- What happens if one shareholder becomes seriously ill?
This is often one of the most important parts of a shareholders’ agreement. Many conflicts arise because the parties have different views on how much each person was actually expected to contribute.
5. Vesting and good leaver/bad leaver
For startups, it may be relevant to agree on vesting. This means that a shareholder’s right to keep the shares in full is earned over time.
The idea is simple: If a founder receives a large ownership stake because he or she is expected to work in the company for several years, it may be unreasonable for that person to keep the entire stake if they leave after a short time.
The shareholders’ agreement can therefore regulate that shares may be bought back in whole or in part if the shareholder leaves.
A distinction is often made between:
- good leaver – the shareholder leaves for acceptable reasons, such as illness or by agreement,
- bad leaver – the shareholder leaves in breach of the agreement, is dismissed due to misconduct, or acts disloyally.
The price of the shares may differ in the two situations. A good leaver may, for example, receive market value, while a bad leaver must sell at a lower price.
Such provisions should be drafted carefully. They can have major financial consequences.
6. Sale of shares and pre-emption rights
The shareholders’ agreement should regulate whether shares can be sold freely, or whether the other shareholders should have the right to buy first.
This may include:
- pre-emption rights,
- consent requirements,
- tag-along rights,
- drag-along rights,
- prohibition on sale for a certain period,
- a requirement that a new shareholder accedes to the shareholders’ agreement.
In small companies, it is often important to control who enters the ownership structure. If you start a company with one or two others, you normally do not want one of them to be able to sell their shares freely to an unknown third party.
7. Tag-along and drag-along rights
Tag-along rights mean that minority shareholders can require that their shares are sold on the same terms if the majority sells.
This protects the minority from being left behind with a new controlling owner they did not choose.
Drag-along rights mean that the minority may be required to sell if a sufficiently large majority wants to sell the company.
This can be important to make the company saleable. A buyer often wants to acquire 100 percent of the shares. Without drag-along rights, a small minority may block a sale.
Both mechanisms should be clearly regulated.
8. Financing and capital needs
The company may need more capital. The shareholders’ agreement should therefore regulate how future financing is to be handled.
Relevant questions include:
- Are shareholders obliged to contribute more capital?
- Should financing be provided as loans or share capital increases?
- What happens if one shareholder cannot or will not participate?
- Should non-participation result in dilution?
- Who can decide to bring in external investors?
Without regulation, capital needs can create conflict. One shareholder may want to grow quickly and raise capital, while another may want to avoid dilution.
9. Dividend policy
The Norwegian Private Limited Liability Companies Act sets limits on when a company may distribute dividends. The company must, among other things, have adequate equity and liquidity.
Within the legal framework, the shareholders may nevertheless agree on a dividend policy.
Example:
- The company shall generally reinvest profits during the first three years.
- No dividends shall be distributed until certain loans have been repaid.
- If the company has profits and adequate liquidity, a certain portion shall be considered for distribution.
Such regulation can be useful if the shareholders have different goals. Some may want regular dividends, while others may want growth.
10. Competition and loyalty
The shareholders’ agreement should often include provisions on competition, loyalty and side projects.
This is particularly important in small companies where the shareholders are active in the business.
Relevant questions include:
- Can shareholders carry on competing business?
- Can they own shares in competitors?
- Can they take customers or employees to another company?
- What happens if a shareholder starts a new project in the same market?
Such provisions must not be unreasonably broad, but they can be important to protect the company.
11. Confidentiality
Shareholders may gain access to sensitive information about the company, customers, technology, finances and strategy.
A shareholders’ agreement should therefore often include confidentiality provisions. This is particularly relevant where not all shareholders work in the company, or where some are also involved in other businesses.
12. Death, illness and divorce
In small companies, major problems can arise if a shareholder dies, becomes permanently ill, goes bankrupt or has shares transferred as a result of divorce or separation.
The shareholders’ agreement can regulate what happens in such situations.
Example:
- The other shareholders have the right to purchase the shares upon death.
- The shares are to be valued according to an agreed model.
- Heirs cannot automatically enter as active owners.
- The shares must be offered to the other shareholders before being transferred to others.
Such provisions may feel uncomfortable to discuss while cooperation is good. That is precisely why they should be clarified early.
13. Dispute resolution and deadlock
A shareholders’ agreement should regulate what happens if the shareholders become deadlocked in a dispute.
This is particularly important in companies with two owners holding 50 percent each. Without a mechanism for resolving disagreement, the company may become paralysed.
Possible solutions include:
- obligation to negotiate,
- mediation,
- chair with a casting vote,
- right or obligation to buy each other out,
- bidding process between the shareholders,
- sale of the company if the conflict is not resolved.
Deadlock provisions should be carefully adapted to the company. A mechanism that looks tidy on paper may produce unfortunate results if the parties have very different financial strength.
14. Breach and sanctions
The shareholders’ agreement should state what happens if a shareholder breaches the agreement.
Possible sanctions include:
- liability for damages,
- contractual penalty,
- obligation to sell shares,
- loss of special rights,
- temporary loss of contractual voting rights,
- termination or cancellation of the agreement.
A practical problem is that it can often be difficult to prove financial loss. For that reason, it may in some cases be sensible to agree on a contractual penalty, meaning a pre-agreed amount payable for certain breaches.
Does the shareholders’ agreement bind new shareholders?
As a general rule, a shareholders’ agreement does not automatically bind new shareholders.
If a shareholder sells shares to a third party, the agreement should therefore require the buyer to accede to the shareholders’ agreement as a condition for the transfer.
This should also be followed up in practice. It should not only be stated in the agreement. In a sale, the buyer should actually sign a deed of adherence.
If this is not done, the company may end up with a new shareholder who owns shares in the company but is not bound by the shareholders’ agreement.
Do shareholders’ agreements have corporate law effect?
The starting point is that shareholders’ agreements do not have corporate law effect. This means that the agreement normally does not bind the company’s corporate bodies in the same way as the articles of association.
The board must safeguard the interests of the company, not only the interests of the shareholders who entered into the shareholders’ agreement. If a shareholders’ agreement states that the board must act in a certain way, this cannot automatically override the board’s duties under company law.
This is particularly important where the company has creditors, employees or minority shareholders who are not parties to the agreement.
In some situations, a shareholders’ agreement may nevertheless have practical or indirect significance. If all shareholders are parties to the agreement, and the agreement concerns matters that only affect the shareholders’ own interests, it may in practice have strong governing effect. Even then, matters intended to have clear corporate law effect should generally be included in the articles of association.
Can a shareholders’ agreement create a group relationship?
In some cases, a shareholders’ agreement may also be relevant to whether a group relationship exists.
Under Norwegian company law, a limited liability company may be a parent company if, by agreement, it has a controlling influence over another company.
This may be relevant, for example, where a shareholder obtains the right by agreement to control the voting of other shareholders, so that the shareholder in reality obtains controlling influence over the company.
This is not the most practical issue in ordinary founder agreements, but it shows that shareholders’ agreements may in some cases have effects beyond the purely internal relationship between the parties.
Tax and shareholders’ agreements
Shareholders’ agreements may also have tax consequences.
In Rt. 2014 p. 760 Terratec, the issue concerned employee shareholders who had rights under a shareholders’ agreement and later subscribed for shares at nominal value. The case mainly concerned procedural questions about which legal arguments could be raised before the courts in a tax case, but it illustrates a practical point: shareholders’ agreements may be relevant when assessing whether a benefit is connected to employment, capital, risk or other circumstances.
This is particularly relevant where shareholders are also employees, consultants, lenders or guarantors for the company.
If a shareholder is allowed to buy shares cheaply, receives special subscription rights or receives other financial benefits, it should be considered whether this may have tax consequences.
Shareholders’ agreement or articles of association?
A practical question is what should be included in the articles of association, and what should be included in the shareholders’ agreement.
As a simple rule of thumb:
- Matters that should clearly bind the company and new shareholders should be considered for inclusion in the articles.
- Matters that primarily concern the internal cooperation between shareholders can often be regulated in the shareholders’ agreement.
- Sensitive or commercially private matters are often better suited for the shareholders’ agreement.
- Matters concerning transfer restrictions, consent, pre-emption rights and share classes should be considered carefully in relation to both the articles and the shareholders’ agreement.
Often, the best solution is a combination. The articles provide the overall corporate law framework, while the shareholders’ agreement regulates the details between the owners.
Common mistakes in shareholders’ agreements
Many shareholders’ agreements are written too late, too vaguely or too generally.
Common mistakes include:
-
The agreement is entered into only after a conflict has arisen
By then, it is often too late. The shareholders’ agreement should be entered into while the parties still agree. -
The agreement does not describe what the shareholders are expected to contribute
If contribution is important, work obligations and expectations should be regulated. -
There are no rules for what happens if someone leaves
This is one of the most common causes of conflict in startups. -
The pricing rules for share transfers are unclear
Disagreement about valuation can create long-running conflicts. -
New shareholders are not required to accede to the agreement
The agreement may then gradually lose practical importance. -
The agreement is not coordinated with the articles of association
Conflicts between the articles and the shareholders’ agreement can create uncertainty. -
The agreement is too complicated
A shareholders’ agreement should be thorough, but it must also be understandable and usable.
When should you make a shareholders’ agreement?
You should consider a shareholders’ agreement if:
- several people are starting a company together,
- one or more shareholders will work in the company,
- some contribute capital and others contribute work,
- you want rules on pre-emption rights or transfer restrictions,
- you want to regulate what happens if someone leaves,
- you plan to bring in investors,
- the company will own valuable intellectual property,
- you want to prevent shares from ending up with outsiders,
- you want clear rules in case of conflict.
In a single-shareholder company, a shareholders’ agreement is normally not necessary. But as soon as there is more than one owner, the question should be considered.
Summary
A shareholders’ agreement is one of the most important documents when several people own a company together.
The agreement can regulate the owners’ rights, obligations, voting, work contribution, share transfers, dispute resolution and what happens if one shareholder leaves or wants to sell.
At the same time, it is important to understand that the shareholders’ agreement normally only binds the parties. It does not replace the articles of association, and it does not automatically bind the company, the board or new shareholders.
The shareholders’ agreement should therefore be drafted precisely, adapted to the company and coordinated with the articles of association.
When cooperation is good, a shareholders’ agreement may feel unnecessary. In practice, that is often exactly when it should be entered into.
Stift helps you start properly
At Stift, we help you set up a Norwegian limited liability company digitally – from incorporation documents to registration in the Norwegian Register of Business Enterprises.
If there will be several owners, you should also consider a shareholders’ agreement early. It creates clearer rules for the cooperation and may prevent conflicts later. Contact us to get started.