Companies With More Than One Shareholder Need Shareholder Agreements!
Shareholder agreements are contracts between two or more shareholders which governs the relationship between shareholders. Shareholder agreements define the rights and obligations of each shareholder regarding the management of the corporation and the transfer of its shares. It forces the shareholders of the corporation to address issues and evaluate all aspects of their business. Corporate lawyers, when working with companies, raise ideas that shareholders may not have contemplated in the first place. The following are ten reasons why a company should have a shareholders’ agreement.
Future Must Reads For Business Owners:
1) Prevention of Legal Disputes
When a business relationships begins, individuals don’t envision the relationship breaking down. They envision a long-term relationship of cooperation and trust. Unfortunately, disputes or disagreements are bound to arise which can lead to litigation. Litigation is time consuming, expensive and ultimately harmful to a business. A shareholders’ agreement provides a mechanism and framework for shareholders of a corporation to effectively deal with any disputes that arise between the shareholders without proceeding to court.
2) Restrictions on the Transfer of Share
Shareholder agreements can prevent shares from being sold and transferred to individuals that are either unknown or have undesirable qualities for current shareholders. These restrictions allow existing shareholders to participate in new offerings and approve new or replace partners of the business that were never contemplated at beginning of the business relationship. One mechanism that is typically in place in place to protect the interests of both the selling shareholder and remaining shareholders is a “right of first refusal”. A right of first refusal allows a shareholder to sell their shares to a third party, but only if they first offer the same terms to existing shareholders.
3) Involuntary Share Transfer
Current Shareholders will want to ensure that shares do not fall in the hands of any third parties through the following events;
• Death of a shareholder;
• Bankruptcy of a shareholder; or
• Matrimonial proceedings a shareholder may be going through.
Shareholder agreements can provide a mechanism for existing shareholders with ability to buy out any unwanted third parties.
4) Funding Arrangements and Preventing the Dilution of Share Holdings
Shareholder agreements can provide the corporation with the ability to put in a place a capital call which allows the corporation to bind the shareholders to contribute additional funding to the corporation proportionate to their shareholdings. Without this provision, the corporation may not require shareholders to contribute additional capital. In the event of equity financing, existing shareholders want to preserve their interest within the corporation and prevent any dilution to their shareholding. A shareholders’ agreement can guard their interest by providing shareholders with a pre-emptive right. This allows existing shareholders, if they desire to purchase share on a pro-rate basis, to ensure their interest within the corporation is not diluted.
5) Restrict the Power of Directors
Typically, business decisions of corporation are left to the board of directors. In a shareholders’ agreement, shareholders can limit a director’s discretion. This mechanism provides shareholders of the corporation with greater control over the day to day operations of the Corporation.
6) Exit Strategy for Shareholders
Shareholders may want to exit a corporation for numerous reasons such as: they want to retire, they want to cash out their investment, they simply no longer want to be involved with the corporation or they no longer see eye to eye with the remaining shareholder. A shareholders’ agreement can define the procedure of how a shareholder may exit a corporation. The following are some mechanisms that can be put into place;
a. Shotgun Clause: Allows a shareholder to offer to buy the shares of the other shareholder or to sell their own shares at a specific price. The non-offering shareholder elects either to buy or sell the shares.
b. Put Option Clause: A shareholder can force the corporation or other shareholders to buy them out.
c. Call Option Clause: The Corporation or shareholder can purchase the shares of a shareholder at any time or after the occurrence of an event.
7) Shareholder Agreements Protect Minority Shareholder
A Shareholders’ agreement can provide protection and rights to minority shareholders they may not otherwise have. The following are some rights that may be provide protection to minority shareholders to prevent them from being adversely prejudiced by majority shareholders;
a. A right to proportionate representation on the board;
b. The ability to veto fundamental changes to a corporation; and
c. The requirement of minority shareholder consent regarding any major decision of the corporation.
8) Majority Shareholder Protection
When a majority shareholder wishes to sell his shares to a third party and exit the corporation, a third party may request that all the shares of the corporation be sold to complete the transaction. In order to provide the majority shareholder with an exit strategy, a shareholders’ agreement can provide the majority shareholder with a drag along right. 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.
9) Confidentially, Non- Solicitation or Non-Competition Clause
Shareholder agreements can protect the corporation by implementing clauses that protect the intellectual property of the corporation, prevent the solicitation of clients and employees by current and departing shareholders. Further, shareholder agreements can prevent departing shareholders from competing with corporation.
10) Policies regarding dividends
Shareholder agreements can set out the specific terms as to when or if dividends will be issued. There are many shareholder disputes that arise from this decision. Further, so that all shareholders are treated evenly, regardless of the shareholder class shares they hold, the dividend policy can maintain fairness among all shareholders.
Working Together To Protect Your Company
Want to protect yourself and your company? Call us today so that the corporate lawyers at Kahane Law Office can help you avoid legal mistakes small business owners make. You can connect with us at 403-225-8810 locally in Calgary, Alberta or toll-free at 1-877-225-8817 or email us directly here.