Is a Unanimous Shareholder Agreement Right for your Startup Business?
What is a unanimous shareholder agreement?
A unanimous shareholder agreement, or USA, is an agreement or contract entered into by all of the shareholders or owners involved in a startup company. It’s used as the ”˜go to’ document or rule book governing the relationship among the shareholders. In fact, the USA often extends beyond shareholder relationships and includes restrictions on the freedom of the directors to manage the business of the corporation. Many lawyers and entrepreneurs refer to the shareholder agreement as a ”˜pre-nup’ because rules governing how shareholders exit the corporation are typically included.
Really, there are three primary reasons that unanimous shareholder agreements are used in closely held start-up corporations:
1) setting the rules for governing or managing the corporation;
2) providing a mechanism for resolving deadlocks; and
3) providing mechanisms for the liquidity or transfer of shares.
When is useful?
A unanimous shareholder agreement is particularly useful in closely held startup companies where the shareholders do not want to rely on corporate lawyers and litigators to settle shareholder disputes. Why? The framework for decision making and the clarification of expectations at the initial stages of organizing the corporation provide and inform the mechanisms to resolve many disputes that typically arise in start-ups.
What are the drawbacks?
As with any good thing, there are potential negatives for entrepreneurs to consider when contemplating executing a unanimous shareholder agreement. One of the primary concerns is that some companies will require equity injections from new investors in order to continue growth. New shareholders will become subject to the unanimous shareholder agreement and will have the same rights as the original shareholders in the management of the corporation. Many shareholders of closely held companies will not want to add new shareholders into the management equation. In fact, many shareholders may have entered into the unanimous shareholder agreement precisely for the reason of protecting themselves against having unwanted partners in the business.
Additionally, to the extent that the unanimous shareholder agreement removes powers and responsibilities from the directors and gives it to the shareholders, the shareholders may become subject to the liabilities the directors would otherwise have. Protection from liability for shareholders is an important factor in deciding to incorporate a business in the first place. Consequently, any loss of that protection should be carefully weighed.
a. Vetoes’. Allows shareholders to set rules over how important decisions are made, for example by providing shareholders with a certain amount of holdings veto rights over specified decisions.
b. Mediation or arbitration clauses. Allows the shareholders to provide an alternative mechanism to the courts for resolution of disputes.
2) Shares Issues and Restrictions
a. a unanimous shareholders agreement can set out preemptive rights on new issues and restrictions on the transfers of existing shares. Such restrictions allow existing shareholders to participate in new offerings and approve new or replacement partners to the business.
b. “Buy-sell” or “Shotgun” provision. A Shotgun provision allows one shareholder to offer to either buy the shares of the other shareholders or sell their own shares for a certain price. The non-offering shareholders can then decide to either buy or sell. The theory behind this provision is that the offering party will set a fair price because they will not be certain whether they will ultimately buy or sell. The shotgun provision is an important provision to resolve deadlock and allow for the removal of a shareholder.
c. “Piggy Back” or “Tag-along” provision. If a shareholder is able to sell shares to a third-party, a piggy back or tag-along allows the non-selling shareholders to include their shares in the agreement with the third-party buyer. In other words, a shareholder could tag-along with the seller and exit the corporation.
d. “Drag-along” provision. If a majority shareholder decides to sell its shares it can require the minority shareholders to sale their shares to the buyer as well. This allows a majority shareholder to exit the corporation without a minority shareholder blocking the sale.
There are advantages and disadvantages to entering into a unanimous shareholder agreement. We recommend that you discuss your options with your trusted advisors as early in the business organization phases as possible. Fortunately, your lawyer will have precedents that he or she can use to draft and an agreement that fits your unique requirements. Consequently, having a unanimous shareholder agreement prepared will not cost much.