Introduction
As businesses grow, conflicts may arise due to differing expectations or priorities among team members. Shareholder disputes commonly occur between founders, investors, or employees when stakeholders face misalignments in vision or strategic goals.
This post highlights essential legal tools and mechanisms that shareholders can adopt to manage disputes effectively and ensure business continuity. Deadlock clauses are especially vital for founders and investors as they provide predefined frameworks to resolve conflicts, including exit strategies.
Aligning Expectations Early On
Before bringing in new shareholders, it is crucial for founders to align expectations, particularly before incorporating the company. Key clauses should address issues such as the roles and responsibilities of each founder, decision-making processes, and the company’s strategic direction. Clear agreements on these aspects can help prevent conflicts from arising.
Sample Clause:
“Each Founder agrees to the following roles and responsibilities:
(a) [Founder A] shall oversee [specific responsibility];
(b) [Founder B] shall manage [specific responsibility]
Decisions regarding [key matters] shall require unanimous approval of all Founders. Strategic direction shall be reviewed annually and aligned with the business plan approved by the majority of the Founders.”
In cases where shareholders cannot reach an agreement on significant decisions—like a 50/50 ownership deadlock—deadlock clauses become indispensable to prevent operational paralysis.
Sample Clause:
“In the event of a deadlock where shareholders holding equal voting rights (e.g., 50/50 ownership) cannot agree on a resolution after [number of days], the following process shall apply:(a) The matter shall be referred to an independent mediator agreed upon by the parties.(b) If mediation fails, either party may trigger a buy-sell mechanism under the Shotgun Clause (see below).(c) If neither option is exercised, the matter shall proceed to arbitration as outlined in the Arbitration Clause.”
Shotgun or Russian Roulette Mechanism
The “Shotgun” or “Russian Roulette” clause allows one shareholder to offer to buy another’s shares at a specific price. The recipient must either accept the offer or purchase the initiating shareholder’s shares at the same price.
This approach is a more aggressive form of a buy-sell agreement and is rarely included in startup shareholders’ agreements. The practical challenge lies in ensuring that shareholders possess sufficient liquidity to execute such a transaction based on share valuations.
Sample Clause:
“Any Shareholder (“the Offeror”) may offer to purchase the shares of the other Shareholder(s) (“the Offeree”) at a specific price (“the Offer Price”)
(a) The Offeree must, within [x number of days], either:
(i) Accept the Offeror’s offer and sell their shares at the Offer Price; or
(ii) Purchase the Offeror’s shares at the same Offer Price.
(b) If the Offeree fails to respond within the stipulated timeframe, the Offeror shall have the right to purchase the Offeree’s shares at the Offer Price.”
Put and Call Options Mechanism
Put and call options are mechanisms for shareholder buyouts in specific situations:
Put Option: Allows a shareholder to require another party to purchase their shares at a pre-agreed price or valuation.
Call Option: Enables a shareholder to compel another to sell their shares under defined circumstances, such as deadlocks or breaches of the agreement.
These clauses are typically exercised in scenarios like shareholder incapacity, death, bankruptcy, or contract breaches, offering flexibility for dispute resolution while enabling the business to move forward without uncooperative shareholders.
Sample Clauses:
Put Option
“Shareholder A (the ‘Option Holder’) may, upon the occurrence of [specific event, e.g., deadlock or breach], require Shareholder B to purchase their shares at a price determined by [valuation method, e.g., fair market value or a pre-agreed formula].”
Call Option
“Shareholder A (the ‘Option Holder’) may, upon the occurrence of [specific event, e.g., shareholder incapacity or bankruptcy], require Shareholder B to sell their shares to Shareholder A at a price determined by [valuation method].”
Casting Vote Mechanism
In the event of a deadlock, particularly in board-level decision-making, the chairperson is typically given a casting vote to resolve the tie. Often, the chairperson is a designated majority shareholder or a lead investor’s nominee appointed for this purpose.
“If the Board of Directors is unable to reach a majority decision on any matter due to a tied vote, the Chairperson of the Board shall have a casting vote. The Chairperson shall be [nominee of the majority shareholder/lead investor] and shall exercise the casting vote in good faith, considering the best interests of the company.”
Exit through Company Sale
When disputes remain unresolved, the shareholders’ agreement can outline an organized process for selling the company entirely.
An exit often occurs through a trade sale, where a third-party buyer acquires shares to deliver value to all stakeholders. Drag-along rights can be useful in this situation, ensuring that dissenting minority shareholders cannot obstruct the sale.
Sample Clause:
In the event shareholders cannot resolve a dispute through alternative methods, the company shall initiate a trade sale process. The following steps shall apply:
“(a) A third-party buyer shall be identified and approved by shareholders holding at least [e.g. 75%] of shares;
(b) Drag-along rights shall apply to ensure dissenting minority sell their shares on the same terms and conditions as the majority
(c) Proceeds from the sale shall be distributed proportionately based on shareholding.”
Arbitration/Mediation Clauses
If deadlocks persist without a casting vote or designated independent third-party involvement, arbitration or mediation clauses can provide alternative dispute resolution mechanisms.
Arbitration: Disputes are settled by an arbitrator or arbitration panel.
Mediation: Parties engage in facilitated discussions to resolve issues before resorting to litigation.
These methods maintain confidentiality as proceedings occur privately, unlike court processes. However, they can be costly due to mediator/arbitrator fees and legal representation expenses, which may limit their practicality.
Sample Clause
“Any dispute arising out of or relating to this Agreement shall first be submitted to mediation under the rules of [Mediation Center/Institution] within [number of days]. If mediation fails, the dispute shall be referred to binding arbitration in accordance with the rules of [Arbitration Institution]. The arbitration shall take place in [location] and the decision of the arbitrator(s) shall be final and binding on all parties.”
Voluntary Winding Up/Liquidation
If all other options fail, shareholders may agree to voluntarily wind up the company in cases of serious, irreconcilable disputes. This allows for the sale of company assets and distribution of proceeds, although usually at a reduced value due to the timing of the liquidation.
Winding up should always be considered a last resort, as it can result in significant losses for all stakeholders.
Sample Clause:
““In the event of an irreconcilable shareholder dispute that cannot be resolved through other mechanisms, the shareholders may, by a resolution passed by at least [percentage, e.g., 75%], agree to voluntarily wind up the company. The assets of the company shall be liquidated, and the proceeds shall be distributed to the shareholders in proportion to their shareholding after settling all debts and liabilities”
Summary
Shareholder disputes, especially those involving key individuals in a startup, can jeopardize the company’s stability and future. Effective dispute management depends on having the right legal mechanisms in place from the outset.
A startup lawyer can help incorporate tools like casting votes, “Shotgun” clauses, or put and call options into a shareholders’ agreement. These mechanisms allow for structured dispute resolution or orderly exits, protecting the interests of founders and investors while ensuring the company remains operational during challenging times.
Looking for a startup lawyer to assist you with your transaction? Contact us to schedule a complementary consultation
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