Shareholders’ Agreements

All corporations with more than one shareholder should have a Shareholders’ Agreement in place. This is a legally binding document that outlines the rights, responsibilities, and expectations among the shareholders. A proper Shareholders’ Agreement addresses key issues such as the decision-making process, dividend policies, dispute resolution mechanisms, and restrictions surrounding the transfer of shares.

When two or more parties agree to run a business together, they don’t often foresee conflict. However, from our experience, successful founders who are serious about the stability of their business always ensure that a Shareholders’ Agreement is in place because they know the importance of hoping for the best while planning for the worst. A Shareholder’s Agreement acts as a proactive tool to prevent conflicts that can hinder growth. As such, it is an essential investment in the foundation and long-term prosperity of a business.

A Shareholders’ Agreement protects shareholders’ rights and ensures that everyone is on the same page. It also governs what happens in a worst-case scenario such as if a shareholder dies or if a deadlock issue arises. By entering into a Shareholders’ Agreement (ideally in the beginning when first forming a new business), you will reduce the chance of conflict and confusion between shareholders and have a clear framework for resolving disputes down the road.

Legal counsel can draft a custom Shareholders’ Agreement for you that suits the particular needs of your business and the particular dynamic between the shareholders.

Shareholders’ Agreements act as a safety net when disagreements arise about the company’s direction. They do so by outlining a fair and efficient process for resolving such disputes. Imagine a scenario where shareholders cannot agree on a crucial business move. Without a pre-defined dispute resolution mechanism, one shareholder could stall progress by refusing to cooperate. This gridlock could prevent the company from passing necessary resolutions and seizing important business opportunities which results in lost profits, legal issues, missed deadlines, and potential resentment.

Moreover, operating without a Shareholders’ Agreement can create enormous stress and uncertainty when unexpected events occur. For example, the unexpected death of a shareholder may present serious challenges for the surviving shareholders. In the absence of a specific agreement, the deceased’s shares typically pass to their estate. This can create an unintended partnership between the surviving shareholders and the estate, which may not have been envisioned by any party when they initially invested. This unforeseen collaboration can introduce significant complexities into the day-to-day operations of the business.

Finally, a well-drafted Shareholders’ Agreement will have clauses that protect the rights of the minority shareholders. Or, it may protect the rights of majority investors who likely have different business goals from other shareholders.

Here are some of the key elements that should be included in a Shareholder’s Agreement:

• Share ownership and structure, including details about how new shares will be issued
• Valuation mechanism which sets out the method for valuing the company or its shares
• Transfer restrictions which typically requires specific thresholds of approval before shares can be transferred to another party
• Voting rights which specifies the rights of each shareholder to participate in decision-making
• Dividend distribution policies which outlines how and when profits will be distributed among shareholders
• List of business decisions which require shareholder approval such as mergers and acquisitions, changes to the core business activities, selling a substantial portion of the assets of the corporation, or forming subsidiaries, etc.
• A compulsory buy/sell provision, otherwise known as a “shotgun clause,” which requires shareholders to purchase the shares of another shareholder if certain events occur
• Piggy-back provisions which protects the rights of minority shareholders in the event that the majority shareholders want to sell their shares to a third party
• Drag-along provisions which forces minority shareholders to sell their shares in the event that the majority shareholders want to sell their shares to a third party
• Right of first refusal provisions which ensure that any shareholder selling their shares must first offer them to the current shareholders, preventing shareholder ownership from becoming diluted
• Shareholder loan provisions which outline how loans made by shareholders to the company must be repaid
• Investors rights provisions which give certain investors greater rights such as the right to liquidate or appoint directors to the board
• Key person insurance provisions
• Provisions triggered by the death or disability of a shareholder
• Confidentiality and non-compete clauses which establishes confidentiality obligations for shareholders and prevent shareholders from engaging in competing businesses

Finally, the Shareholders’ Agreement should set out a mechanism for dispute resolution. The contents of a Shareholders’ Agreement should be tailored to the unique needs of each business. As this agreement is so complex, it is important to obtain professional legal services.

Shareholders’ Agreements are often confused with Partnership Agreements. However, these are two totally different agreements.

Both agreements are contracts that outline the rights and responsibilities of the parties in a business. However, they are used for different legal structures. A Partnership Agreement refers to an agreement between partners of a partnership whereas a Shareholders’ Agreement refers to an agreement between the shareholders of a corporation.

The key difference here is that a partnership is not a separate legal entity which means that partners of a partnership are jointly and severally liable for the debts of a partnership whereas a shareholder’s liability is limited.

As a legally binding contract, a Shareholder Agreement is legally enforceable as long as it meets all of the elements of a valid contract. Therefore, if a shareholder breaches the terms of the agreement, then the other shareholders may seek legal remedies such as specific performance, damages, or injunctive relief to enforce the agreement and protect their interests. Just ensure that all shareholders as well as future shareholders who should be bound by the agreement have duly signed it.

When it comes to Shareholder Agreements, it is best to get a lawyer who is experienced in business law involved. A lawyer who has specialized knowledge of corporate law will ensure that your legal needs are protected. They will raise awareness of any blind spots you may have. For example, they may recommend clauses that will protect you in ways that you would not have otherwise thought of. Or at least help you truly understand what you are getting into.

We can provide advice on common practices and mechanisms and review your Shareholder Agreement or other legal documents to identify any potential risks and clarify each party’s responsibilities. Set up a free consultation to discuss your business legal needs today.