How a Shareholders’ Agreement Can Save Your Business

The moment you have more than one shareholder in your corporation, you need a Shareholders’ Agreement. A Shareholders’ Agreement is a written contract between the shareholders of a corporation that regulates the relationship of the shareholders by setting out the rights, restrictions and obligations of each shareholder relative to one another. It addresses foreseeable disputes among shareholders by clearly setting out provisions for addressing what happens when a shareholder wants to leave the corporation or sell their shares, and what happens to the shares in the event of a shareholder’s death, incapacity or disability.  

Why Is a Shareholders’ Agreement Important?

At the outset of a business relationship, it might be difficult to foresee a situation where shareholders or business partners would encounter a fall out, however, disagreements among business partners do occur down the line. It is easier right at the outset of the business relationship, to formalize and document in a Shareholders’ Agreement, the approach that would be taken if the relationship turns sour.

What Should I Include in a Shareholders Agreement?

A properly drafted Shareholders’ Agreement will provide for different exit strategies in the event that the shareholders can no longer carry on business together.

1) Death Clause

In the event of the death of a shareholder of the corporation, what happens to the shares of the deceased shareholder? Would the shares be redeemed by the corporation, sold to the surviving shareholders of the corporation or would the deceased shareholders’ spouse or personal representative automatically own the shares of the deceased thereby jointly owning and running the business with the surviving shareholders? 

The death of a shareholder may lead to the surviving shareholders of the corporation finding themselves in a sudden business relationship with a business partner they never intended. This is where a Shareholders’ Agreement comes in. It provides direction regarding the sale of the shares of the deceased shareholder to the surviving shareholders and provides the family of the deceased shareholder with the cash equivalent instead of the shares itself.

2) Disability Clause

If a shareholder becomes permanently disabled or incapacitated, they might no longer be able to participate in the corporation in a meaningful way, however, the incapacitated shareholder would still be entitled to the distribution of profits or dividends each year. A Shareholders’ Agreement could protect against this by having provisions that outlines what happens in the event of the disability or incapacity of a shareholder such as basing profit distribution on whether a shareholder is active or inactive.

3) Exit Strategies

In the event a shareholder wants to exit a business, a Shareholders’ Agreement should provide for what happens to their shares and how the shares are to be valued at the time of the exit. The agreement should provide clauses such as: 

  • Right of First Refusal

Does the exiting shareholder have to offer to sell the shares they own to the remaining shareholders first or do they have a right to sell their shares to anyone outside the business without offering the remaining shareholders first? 

  • Drag-Along and Tag-Along

What happens if a majority shareholder gets an offer from a potential buyer who wants to purchase their shares? Can the majority shareholder force the minority shareholders to join in the sale of shares to the potential buyer? Or can the majority shareholders give the minority shareholders the option to tag-along with them in the share sale and sell their shares along with that of the majority shareholder? A well drafted Shareholders’ Agreement should make provisions for circumstances such as these.

  • Shot-Gun Clause 

A Shareholders’ Agreement may contain a shot-gun clause which permits a shareholder in a corporation to trigger a forced purchase-sell situation where the triggering shareholder offers to buy the shares of the remaining shareholders at a specific price. The remaining shareholders may either accept the offer to sell their shares to the triggering shareholder at the requested price or they are forced to buy the triggering shareholder’s shares at the same price and terms initially offered by the triggering shareholder.

4) Financing

At different stages in the life-cycle of a business, access to capital would be required. A Shareholders’ Agreement may have clauses covering how a business would be funded when the need arises. The Agreement may also outline situations where shareholders may provide funding to the business and highlight mode of repayment.

5) Dispute Resolution Provisions 

A Shareholders’ Agreement may serve as a rulebook which sets out the process of dispute resolution between shareholders by including dispute resolution provisions such as a requirement that shareholder disputes are to be settled privately through arbitration. 

Conclusion

A Shareholders’ Agreement can be compared to a pre-nup agreement between couples prior to marriage, it serves as a guide to solving potential issues that may come up down the line when shareholders of a corporation are no longer getting along by providing clauses that adequately protect the interests of such shareholders. 

At the heart of every well drafted Shareholders Agreement is an experienced legal professional. If you are considering preparing a Shareholders’ Agreement for your business, contact the business lawyers at Rabideau Law.

The blog published by Rabideau Law is intended as general information only and does not serve as legal advice. By viewing the blog posts, the reader understands there is no solicitor-client relationship established. Readers are urged to consult the business and corporate lawyers at Rabideau Law on business related concerns.