MLLStart! FAQs: Essentials of Shareholders' Agreements (SHA) in five questions and answers


SHA are a widely used instrument to coordinate shareholder interests – also among start-ups. Many founders ask themselves when the right time to conclude a SHA is and which provisions it should contain. This MLLStart! FAQ provides answers to the most important questions.

This article is also available in German.

Question 1: What is a SHA and why should I, as a founder, conclude a SHA with my fellow co-founders?

Under Swiss company law, shareholders of a company have only one obligation: to pay up for the shares they subscribed for when founding/establishing the company or when increasing its capital. There are no further obligations. However, especially in the case of start-ups, the involvement of the founders in the company or the coordination of the voting behavior of shareholders is of great importance. If shareholders are to agree on further obligations that go beyond the payment obligation, it makes sense to conclude a SHA.

Question 2: When is the right time to conclude a SHA?

Should a SHA be concluded directly at the time of the foundation of your start-up? Or only during the first round of financing when investors are on-boarded? First of all: there is no obligation to conclude a SHA. However, it often makes sense to enter into a SHA at an early stage of the company (sometimes even right at the time of foundation), unless the company is a one-man/woman show. The content of SHAs at an early stage of the company are usually limited to a few core issues (see question 3). As the start-up matures and investors become more professional, the density of regulation in the SHA typically increases (see question 4).

Question 3: What are the core provisions in a SHA among co-founders?

Within the limits of mandatory law, the parties are free to define the content of the SHA depending on their objectives. This follows from the principle of contractual freedom. SHAs of early stage companies typically cover the following core issues:

Right of First Offer and/or Right of First Refusal (ROFR): SHAs regularly stipulate that the parties involved may only sell their shares subject to certain modalities. If a right of first offer (Vorhandrecht) has been agreed upon, a shareholder willing to sell must first offer his or her shares for sale to the other contracting parties before approaching third parties. Only when the other contracting parties have waived their right of first offer, the selling party may offer the shares to a third party. If a share purchase agreement is then concluded with a third party, some SHAs also grant the other parties a ROFR (Vorkaufsrecht). The effect of the ROFR is that the other shareholders can enter the share purchase agreement as buyers and acquire the shares on the terms agreed with the third party.

Purchase rights: In the event that the shares change hands without the intervention of a shareholder (e.g. in the event of a shareholder’s death or due to a matrimonial property dispute in the event of divorce, or if the shares are seized in debt collection and publicly auctioned), a purchase right of the other shareholders to the concerned shares can be agreed. The purchase right can be used to grant the other parties the right to purchase the shares from the concerned shareholder (or his/her legal successor, as the case may be) at a price fixed in advance. The parties should define a valuation method for setting the price in the SHA.

Coordination of voting behavior: In principle, all matters in the competence of the General Meeting of Shareholders may be the subject of coordination among the shareholders. Typical matters for a coordinated voting behavior are, for example, the election of the person(s) proposed by a certain shareholder to the Board of Directors, or no-dividend resolutions for a certain period of time, etc.

Question 4: What kind of provisions do Venture Capital Investors often request?

With the increasing professionalization of investors in your startup, the content of the SHA will also change. Venture capital investors often request the following rights:

Seat on the Board of Directors / Observer Seat: Investors often ask to be represented by one (or more) representatives on the Board of Directors. By sitting on the Board, the investor may directly shape the company’s overall management. If a strategic investor invests in your startup, it is often advantageous for all parties to grant the investor a seat on the Board: the investor can support the startup with its network and know-how and often help the company to take a decisive step forward. As an alternative to a seat on the Board of Directors, may opt for a seat as Board observer. A Board observer is invited to all Board meetings, but has no voting rights.

Veto rights: The SHA can stipulate that for certain (precisely defined) decisions in the Board of Directors and the General Meeting of Shareholder, stricter attendance requirements or decision quorums apply. In this case, the parties must agree on the set of resolutions for which such tightened quorums apply (they are typically called „Important Board Matters“ and „Important Shareholder Matters“). The investor will try to set the quorums in such a way that he/she has a veto right on the above-mentioned resolutions; in other words, a resolution will only be passed if the investor agrees. The quorums for the resolutions may be reflected in the articles of association, which in turn secures the contractual agreement under company law (see question 5). However, the inclusion of such quorums in the articles of association increases the complexity and costs of implementation of the financing round.

Information rights: By law, shareholders only have very limited access to (financial) information about the company. In principle, the right to information is limited to the shareholders being able to inspect the annual report and the audit report in the run-up to the ordinary General Meeting of Shareholders and to request further information at the meeting itself. Therefore, the right to be regularly informed about the course of business (even between the annual General Meetings of Shareholders) is often found in SHAs. This can be done, for example, by sending quarterly or half-yearly financial reports or even monthly management accounts.

Dividends and Liquidation preference: To secure their investment, investors can be granted preferential rights to dividends or liquidation proceeds (i.e. what remains after the liquidation) or sales proceeds in the event of an exit. There is a lot of room for negotiation here, and certain standards have developed over the past years. A precise formulation of these preferential rights is essential..

Preference for Subscription Rights: By law, every shareholder has a subscription right to newly issued shares that corresponds to the ratio of his previous shareholding in the share capital. The subscription right applies provided that it has neither been cancelled nor restricted by the General Meeting of Shareholders (which is only permitted within narrow limits). By giving preference for subscription rights to investors, they may be assured that they will be able to subscribe for a larger proportion of the newly issued shares (or even have a preferential right to all new shares). It is possible to secure the dividend, liquidation and subscription right preference under company law by mirroring the provisions of the SHA in the articles of association (this is often requested by investors). In contrast to dividend and liquidation preferences, which are very hard to avoid in VC financing rounds, we find that subscription right preferences are less common.

Protection against dilution: In order to protect their investment from so-called „down-rounds“ (i.e. capital increase at a lower pre-money valuation compared to the post-money valuation of the previous capital round), investors may request protection by a compensation mechanism. The design of this economic protection against dilution again leaves plenty of room for negotiation between investor-friendly and founder-friendly options.

Other frequently encountered provisions: Lock-up period; Drag-Along or Co-Sale Obligation, Tag-Along Right, non-competition and non-solicitation, margin requirements, personal performance obligations, and many more.

Question 5: What are the limits of the SHA and what safeguards can be built in?

The SHA only acts as a contract between the parties. If a shareholder violates the SHA, for example by violating the voting agreement, from a corporate law perspective the resolution is still valid, provided that the requirements set forth in the Code of Obligations and the articles of association of the company have been met. However, if a shareholder has violated a contractual obligation he/she may be liable to pay damages to the other shareholders (whereby the damages must be proven). Similarly, a sale of shares would be valid under civil law, even if the shareholder violated the restrictions on the disposal of shares set out in the SHA (e.g. because he/she did not offer the shares for sale to the remaining shareholders in advance, even though a right of first refusal was agreed in the SHA). The following security measures can be taken:

Contractual penalty: A frequently used means of admonishing the parties to comply with the contract is the contractual penalty. Contractual penalties have the advantage that the party entitled to claim damages does not have to quantify or prove the damage caused by a breach of contract (e.g. when a voting commitment clause or a non-competition clause is disregarded). Courts can reduce excessively high contractual penalties to a permissible level.

Share Escrow: Protection against unauthorized share transfers is provided by depositing share certificates with an independent third party (escrow agent). However, a share escrow involves costs (preparation of the escrow agreement, custody of the shares), which is why it is rarely used by start-ups.

Mirroring the rights according to the SHA in the Articles of Association: In the context of the creation of preference shares, certain rights can be reflected in the articles of association. These include preferential rights to dividends and liquidation proceeds as well as preferential subscription rights. Likewise, the increased attendance and resolution quorums can be mirrored in the articles of association. However, the options for structuring the articles of association are limited. For example, shareholders‘ personal obligations (e.g. an obligation to make additional contributions or a prohibition of competition) cannot be laid down in the articles of association of a Swiss stock company.

The MLLStart! Team is glad to advise you on all questions concerning SHAs. Get in touch with us!