A shareholder agreement is an agreement between shareholders of one corporation. It is also called a stockholder agreement. Which provisions consist of a shareholders agreement depends on the corporation and their shareholders, as well as on the purpose of the agreement. It usually explains shareholder’s rights and responsibilities and the document should be stored in the minute book. Although it is not a legal obligation to have a shareholder agreement, it is highly recommended.
Is shareholder agreement a contract?
Yes, it is. It is a binding contract that is confidential between the parties (other shareholders). A shareholders agreement is covered by the common law and the Ontario Business Corporations Act. It determines who can become a shareholder and who will work on the board of directors. It also regulates situations, such as what will occur when a shareholder passes away or is not able to work, when he gets fired or hands in a resignation, or he goes bankrupt.
A shareholders agreement also makes clear how much the shares are worth and if a corporation is obliged to purchase the shares of the former shareholder. All shareholders have to sign the shareholders agreement. It is recommended that someone witness the signing of a shareholders agreement. In that way, a shareholder cannot deny signing the agreement. An additional step you should take to protect a corporation is to notarize the signatures of the shareholders.
What are the elements of a shareholders agreement?
Preamble– it states the parties to the agreement (the shareholders)
Recitals– describes the reasons for joining the agreement and the goals to be achieved by the agreement
Optional vs. Mandatory– depending on the verb you use in the agreement, shall or may, you can determine whether the purchase of the former shareholder’s shares is obligatory or optional.
Right of First Refusal– this clause protects shareholders and the corporation from a decision of a leaving (former) shareholder to sell his/her shares to third parties. The clause prevents a corporation from getting an unwanted shareholder who might not have the same goals for the company.
Determining a Fair Purchase Price– you should consult an accountant for this matter. There are usually two ways to set the price. One way is to determine the price per share in dollars. In that case all the parties should agree with the price and it can be updated/changed annually. Another way is to create a formula for calculating a price and that formula would be used at the given time.
Insurance Policy for Buyout Money- if one shareholder decides to resign, other shareholders may need to cover the expenses of the shareholder’s shares. To prevent this, a corporation should get an insurance policy to get funds for the buyout money.
What are top reasons to have a shareholders agreement?
Shareholders often disagree. That’s why an agreement is necessary. Not only can it regulate the management of one corporation, but it can also help the business stability.
Having that in mind, we compiled a list of top reasons for having a shareholder agreement.
1. Protects (minority and majority) shareholders
A shareholders agreement protects minority shareholders by preventing some decisions that can be accomplished only with the agreement of all shareholders. For example, to issue more shares in a company, or to allow the registration of new members. This agreement gives rights to minority shareholders to take part in decision-making together with majority shareholders. So called tag along provisions enable minority shareholders to join majority shareholders in share sale situations. Share sale situation refers to selling only shares of the majority instead of all shareholders.
At the same time, a shareholders agreement can protect majority shareholders. When a majority shareholder wants to leave the corporation and sell his shares to a third party this agreement can protect him in the following way. So called drag along provision regulates that all minority shareholders need to sell their shares, in situations when a third party wants to buy shares from a majority shareholder under condition a third party buys all the shares of the company.
2. Controls the transfer of shares
Securities laws, particularly the Articles of incorporation can be regulated in a way that shareholders have a right to sell or transfer their shares to any person they choose. This type of provision can be very harmful to a small business or a startup. You never know who will buy the shares of a departing shareholder. A shareholders agreement can put restrictions on the sale of shares by creating a right of first refusal. In other words, when one shareholder wants to sell his shares to the third party, other shareholders can refuse that sale. All shareholders have to agree about share acquisition. In some agreements, it is stated for example that other shareholders have a right of the first opportunity- to buy the shares of a departing shareholder.
3. Resolution of disputes
Disputes are very common in the business world. The shareholders of a corporation can have different opinions, which may result in time consuming and expensive disputes. They are expensive because they usually require a mediator or a litigation lawyer involved. To avoid such unnecessary costs, a shareholders agreement can set out the procedure in the event of a dispute. This kind of agreement provides businesses with an effective mechanism to deal with such disputes.
4. Dividends policies
To take money from your company, you can either sell shares or distribute dividends. Dividends policies are also part of a shareholders agreement. The agreement can determine when dividends will be paid, what shareholders have the right to waive to receive dividends.
Many shareholders tend to have shares in more than one company. That is acceptable as long as the other companies are not a competitor to the first company. A shareholder agreement protects the company by putting restrictions on the shareholders. They are not allowed to have shares in similar companies or to use employees, customers and other assets of one company on the behalf of another company.
6. Protecting investors
People who invest money in one company are also considered to be shareholders. Since they take risks by investing money they often ask for certain provisions to be included in a shareholder agreement. These provisions are designed so the investors have their rights and they are protected from unexpected situations. Investors can require for specific targets and take control of the company if those targets are not met.
7. Unanimous Approval on Important Issues
The agreement can determine the right of shareholders when it comes to voting procedures. It can also determine that some important issues are voted in favor, by all voters. For example, when electing directors or collecting cash from shareholders or getting a loan agreement. These situations require unanimous approval and majority shareholders cannot abuse their power.
Shareholder agreements can be very flexible and they can meet the needs of every business. One agreement can include many provisions such as financing provisions, non-compete clauses, share vesting provisions etc. With this agreement you can set up the standards and know what to do if conflict arises.
Do you need a shareholders agreement?
You cannot predict the future. Misunderstandings and disagreements may arise and this type of agreement can only help you solve the problems in the most cost-effective way. A shareholders agreement protects every shareholder, whether he is a minority or a majority shareholder. It protects the business when one or more shareholders are leaving it, and presents a roadmap that existing shareholders should follow.
What is the purpose of a shareholder?
Shareholders can be individuals but also companies or trust funds. The purpose of a shareholder is to invest money in one company and to make decisions together with other shareholders that will bring benefit to a company. Naturally, shareholders with more voting shares have more control of the company than shareholders with smaller number of shares.
Shareholders are decision makers and those who govern the company. They make resolutions about different issues and manage disputes. Buying shares and becoming a shareholder is a predefined process, regulated by the shareholder agreement. Every agreement clearly states the process of entering the shareholders’ circle and exiting as well. Shareholders can decide the value of shares. When one shareholder wants to exit the company, he will have to get a fair value of shares. At the same time, remaining shareholders should have affordable payments.
A company can compensate the roles by setting up fair values for every role. Return on investment will be realized against the value of investment. Return on equity should also be realized reasonably.
What is a Piggyback clause?
When a shareholder gets a partner he dislikes, he can require from that new shareholder to purchase his shares as well. The shares should be purchased on the same terms. These rights are called Piggyback rights. They are particularly useful to minority shareholders. For instance, when a company gets a new majority shareholder, and a minority shareholder doesn’t want to do business with him. He can request his piggyback rights be exercised and a new majority shareholder is required to buy his shares.
A Power of Attorney clause is another important part of every shareholder agreement. It closes buy/sell transactions, especially those compulsory ones. The clause prevents shareholders changing their minds about what they’ve already agreed on.
When should a shareholders agreement end?
Like everything else, you can agree upon agreement ending terms with other shareholders. If you are a part of a small corporation and you have a firm relationship with your shareholders, you can agree to end everything when all vote in favor to it. On the other hand, if you are not fully confident about your shareholders, you can set up a date when the agreement will end.
If there are disputes or deadlocks happening, you can use a mediator or an arbitrator. In order to save the business, you should try with mediation first and avoid going to court. If you go to court you take a risk of having your company dissolved. A mediator can help you overcome disputes and find the best possible solution for your company.
To prevent all of this from happening, you should make a shareholders agreement which will clearly regulate all possible problems and their solutions before they happen. You need less time and money for crafting a shareholders agreement than going to court.
With the goodwill of all shareholders and the help of a securities lawyer, you can have a shareholders agreement at your desk and prevent misfortunes happening.