Shareholder Agreements

What is a shareholder agreement?

A shareholder agreement is a formal document – a contract – that outlines the rights, responsibilities and expectations of the owners of a business and states the relationships among the various shareholders. It spells out who owns what proportion of the business (how many shares) and what the options and obligations are when shareholders want to sell their shares, become unable or unwilling to participate in the business, or die. One of the agreement’s chief purposes is to ensure a smooth ownership transition in these situations. The document also describes how the company will be set up and run.

Why you should have a shareholder agreement

Often, a shareholder agreement does not come into play until the relationships among shareholders change. But sometimes such a change can be sudden, unexpected and emotionally charged. The agreement ensures that changes to the business’s ownership structure and operations happen in an orderly way and according to the wishes and plans of all shareholders. And that reduces the chances of litigation and the chances that your business will fail as a result of conflict.

Shareholder agreements should outline what your board of directors will look like: how many directors, how they are nominated and what any new investors’ rights will be in terms of a seat at the board table.

The agreement should also protect minority shareholders, such as by requiring unanimous agreement on major corporate issues (and the agreement can describe what those are). Otherwise, the majority shareholders may always get their way and disregard the needs and wishes of minority owners.

A shareholder agreement can help a business’s owners with succession planning by outlining in advance who the new owners of the shares – and thus that portion of the business – will be if a shareholder dies. Having an agreement will also help you attract new investors; they will want to be sure you have an agreement in place before they invest in your business.

Many business owners find that the conversations that are part of the process of creating the agreement are in themselves beneficial because they get owners talking about critical business topics as you launch your business, when you most need to understand where the others stand and make sure you are on the same page.

What your shareholder agreement should include

The agreement should spell out exactly who owns what shares in the company and how ownership will change in various situations (for example, if an owner wants to sell, dies, becomes disabled or retires). Will shares pass to family members, or to other owners? Will shares be offered for sale, and at what price? How will share value be determined?

The agreement should state any restrictions on share ownership and transfer; without such restrictions, you could find yourself with business partners you had not counted on having. The contract should indicate how disputes should be settled (such as by arbitration). It should describe how dividends or other distributions of profits are paid.

Share buyouts should be part of your agreement, in the form of a buy-sell agreement, along with a plan for funding those share purchases. For example, if one of three shareholders dies, and the other two must purchase the deceased owner’s shares from the estate, will they or the business have the cash to make that purchase? The best way to ensure the money is available is to enshrine life and disability insurance in the agreement. A good agreement covers various exit scenarios.

A “shotgun” clause is often included in shareholder agreements as a kind of last resort for solving disputes resulting in the shareholders no longer wanting to work together. Under this clause, one shareholder may offer to buy all shares held by another shareholder, but the other shareholder may turn it around and offer to buy the first shareholder’s shares at the same price – and the first has to agree.

You really should not plan to operate a multi-owner business without a shareholder agreement that has been custom tailored to your business situation. It’s critical that the agreement be prepared when everything’s going well – that is, before you actually need it. Even if the business is operating smoothly now, things can change. As business owners, you’ll save yourselves stress, damaged relationships and money by having a good shareholder agreement, so meet with your business advisors to set one up. To make sure the agreement is fair and equitable, each shareholder should consult with their own tax, accounting and legal experts to ensure their interests are protected.

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