The Importance of Shareholders’ Agreements – The Business Prenup
By Katherine Bayer on 2016/08/12
A shareholders’ agreement is an agreement between the shareholders of a company which generally sets out the shareholders’ rights, privileges and obligations along with the foundation of how the corporation will be set up, managed and run. Having a shareholders’ agreement is a cost effective way of minimizing any issues which may arise later on by making it clear how certain matters will be dealt with and by providing a forum for dispute resolution should an issue arise down the road. Taking the time to sit down and discuss certain issues from the beginning can help eliminate disagreements between shareholders and ensure that everyone is on the same page.
There is no statutory requirement for shareholders of a corporation to enter into a shareholders’ agreement, and therefore a shareholders’ agreement can be quite flexible in terms of what provisions are contained in the agreement and what issues are specifically addressed. In addition, a shareholders’ agreement can override certain requirements set-out in The Corporations Act (Manitoba) or the Canada Business Corporations Act.
As a general rule, corporate law gives the upper hand to the majority shareholder(s) as decisions can typically be made with the positive vote of a simple majority (i.e. 51%). In most jurisdictions there are a limited number of exceptions which require what is called a “special majority”, meaning two-thirds (i.e. 66.67%) of votes, in order to make decisions regarding the fundamental aspects of the corporation. However, in drafting a shareholders’ agreement, the shareholders can decide what percentage is required for certain decisions. For instance, fundamental decisions pertaining directly to the business, financing or business structure may require a unanimous decision by all of the shareholders, while other less important decisions may simply require a majority vote. This is especially important where one shareholder holds a majority of the shares in the corporation as without a shareholders’ agreement, most shareholders’ decisions could be made by the sole majority shareholder leaving the minority shareholder(s) with little or no voice.
Restrictions on Transfers and Ownership of Shares
Restrictions on who can become a shareholder is an important aspect of a shareholders’ agreement. Especially in smaller businesses, it is important to have shareholders who get along with each other and can make decisions together regarding the business. Most corporations require approval of the directors with respect to all transfers of shares, however depending on the composition of the board, this requirement may not always look out for the interests of the minority shareholders.
As time goes on, the personal circumstances of each shareholder can change significantly. This can have a huge impact on the business if a shareholders’ agreement is not in place. For instance, shares in a corporation are considered assets, and therefore, upon the death of a shareholder, the deceased’s shares become part of their estate and subject to the testamentary wishes of the deceased. In other words, in the absence of a shareholders’ agreement which addresses what will happen to a shareholder’s shares upon death, the spouse or children of the deceased could overnight become your new business partner – a scenario which is may not be desirable to the remaining shareholders. A compulsory buy-out provision can be included in the shareholders’ agreement which provides that if a shareholder dies, the remaining shareholders, or the business, will be forced to buy the deceased’s shares, and the executor or administrator of the estate would be required to sell the shares. In addition to the buy-sell provision, a mechanism for valuating the shares at the time of the shareholder’s death can also be agreed on and included.
Other restrictions on transfers and ownership can be included in a shareholders’ agreement including an obligation for employee shareholders to sell their shares in the event that a key shareholder becomes disabled and is no longer able to work or provide the appropriate support to the business, the insolvency of a shareholder or upon retirement or termination as an employee of the business.
Whether at the start-up phase or during operations, or both, a business will require access to capital. A shareholders’ agreement can set out how the corporation will access funds and whether the shareholders are responsible for contributing such funds in accordance with their relative interest in the business. In addition, where not all shareholders are willing or able to contribute funds when needed, a shareholders’ agreement can set out preferential interest rates for those shareholders who do contribute, or restrict the board of directors from declaring any dividends until the shareholder’s loan has been repaid unless the consent of the shareholder has been obtained.
In the event that the corporation will be accessing debt financing from a bank or third-party lender, a shareholders’ agreement can deal with whether shareholders are obligated to give personal guarantees and what will happen in the event that a shareholder, for whatever reason, does not or cannot give a personal guarantee.
A well-written shareholders’ agreement will provide for different exit strategies in the event that the shareholders can no longer be in business together. At the incorporation stage, shareholders should consider what will happen in the event that they no longer get along, a shareholder is forced to move away or someone simply wants out from the business. The best time to talk about this is in the initial stages when everyone is getting along and excited about the new business venture they are embarking on. Agreeing to certain terms from the get-go can eliminate drawn-out and expensive negotiations later on and hurt feelings.
A shot-gun clause allows a shareholder to trigger a forced buy-sell scenario, meaning the “triggering shareholder” makes an offer to the remaining shareholders to buy their shares at a specific price. The remaining shareholders can then either accept the offer to sell their shares at that price or are alternatively forced to buy the triggering shareholder’s shares at the same price.
Other clauses including a drag-along and piggy-back clause can also be included which in the former, forces minority shareholders to sell their shares in the event that a majority shareholder wants to sell all of their shares to a third party, or in the latter, gives the option to minority shareholders to sell their shares along with the majority shareholder.
Reality is that business partners will have arguments and not always see eye-to-eye on all issues. Corporations that have more than one shareholder should consider having a shareholders’ agreement in place in order to set out the expectations of each of the shareholders from the beginning. Having these discussions from the get-go and spending a little bit of money to have a shareholders’ agreement drawn up can save much time, money and effort down the road.
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