Do I need a shareholders’ agreement?

A shareholders’ agreement is strongly recommended for privately held companies where there is more than one shareholder. The following sets out certain issues to consider when determining whether a shareholders’ agreement is needed. The issues set out below are in no way exhaustive as there is no “model” shareholders’ agreement which is appropriate in all circumstances, as each group of shareholders will have unique concerns and priorities. That being said, there are a few basic considerations that most shareholders’ agreements contain.

A shareholders’ agreement will generally outline the following:

  1. a means of dispute resolution — A common dispute resolution mechanism is a “shotgun clause”, which is a clause that permits a shareholder to offer to sell his or her shares to the other shareholders but requires that he or she be prepared to buy the shares at that same price if the other shareholders refuse to buy his or her shares. Other dispute resolution mechanisms include arbitration or mediation;
  2. the protection of minority shareholders and the minimization of the inequality of positions caused by differing shareholdings — A common protection for a minority shareholder is a “tag-along” right, which permits a minority shareholder to participate in a proposed sale of shares by a majority shareholder to a third party. The converse of this is a “drag-along” right, which enables a majority shareholder to force a minority shareholder to participate in the sale of shares by the majority shareholder to a third party. Requiring unanimous approval also serves to protect the minority shareholder;
  3. the agreement of the parties, in advance, on how particular matters will be voted on when a particular resolution or set of circumstances is presented — On important issues, unanimous approval of all of the shareholders can be required. Typical topics that require unanimous approval include: loan agreements, election of directors and cash contributions;
  4. controls on who will be the other shareholders of the Company, both present and future — General corporate law allows for a shareholder to freely transfer his or her shares. This can be an unwelcome surprise for the other shareholders who would prefer to choose who they have as fellow shareholders. As a result, most shareholders’ agreements impose restrictions on the transfer of shares. Restrictions usually require unanimous shareholder approval before a sale is permitted. A right of first refusal is also a common restriction which requires that a shareholder proposing to sell his or her shares must first offer them to the other shareholders;
  5. what happens when one or more of the shareholders dies, divorces, becomes disabled, becomes uninterested in the business, or becomes in some other way unable or unwilling to contribute to the business  — Oftentimes, the shares are bought by the Company, or the remaining shareholders, at some predetermined value which is set out in the shareholders’ agreement; and
  6. what happens when, for whatever reason, the other shareholders no longer want a particular person to remain as a shareholder of the Company — In these circumstances the parties could exercise the “shotgun clause” referenced above, but this could lead to the possibility that the shareholders seeking to buy out the unwanted shareholder are themselves bought out.

Having a well-drafted shareholders’ agreement in place has many advantages including, but not limited to:

  1. having a road map to follow when unexpected changes happen;
  2. preserving the value of the business;
  3. allowing for tax planning;
  4. protecting the remaining shareholders in the event of the death, departure or disability of a shareholder;
  5. minimizing or eliminating miscommunications and discord between the shareholders as a predetermined method is already established to deal with issues which may arise; and
  6. allowing the flexibility to deal with any unique issues which may arise such as financing provisions, share vesting provisions, non-compete clauses, valuations and dividends.

One of the best reasons to put a shareholders’ agreement in place is that it forces the parties to discuss the issues which could arise prior to them facing those issues. Once the agreement is in place, then the parties can carry on with the comfort of knowing that if an issue arises, they will know what to do.

The foregoing is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, please contact the author who would be pleased to discuss the issues above with you, in the context of your particular circumstances.