What is a Shareholders Agreement

It is natural to believe that starting a business with someone you trust will go well. However, even businesses started best friends or family members can fail.

If you and your business partner disagree, the value and even viability of the company you worked so hard to build may suffer. You may have to deal with losing a close relationship as well as a difficult and expensive business dispute litigation.

Fortunately, a shareholders agreement can help prevent this from happening. It is a document you create when times are good, to plan for the not so good. Continue reading to learn more.

What Is a Shareholders Agreement?

A shareholders agreement is a legally enforceable contract signed by shareholders. Normally, the agreement includes all of the stockholders. Yet, it is not uncommon for only a subset of the company's shareholders (for example, holders of a particular class of shares) to sign into a legal agreement.

A shareholders agreement safeguards the shareholders' investments in the company. Apart from dictating how the company is run, it also ensures a fair relationship between the various shareholders.

Typically, a shareholders’ agreement:

• describes what rights and obligations the shareholders have
• regulates the sale of shares in the company
• determines the way the company will be run
• ensures minority shareholders have some level of legal protection
• defines how vital decisions will be made.

A shareholders agreement typically covers a wide range of scenarios, including, but not limited to:

• the company’s dividend policy 
• the funding for the company’s business
• the management of the company
• the valuation of the company’s shares
• the procedure that must be followed for transferring shares
• deadlock situations

A shareholders' agreement reduces the chance of a disagreement between shareholders by giving clear instructions on how to handle certain situations. It also establishes a mechanism for addressing and resolving a dispute, should one occur.

3 Types of Shareholder Agreements

Buy-sell agreements

A buy-sell agreement specifies how and when surviving shareholders can purchase the shares of a former shareholder in the case of their retirement, death, or disability.

Shareholder agreement

A shareholder agreement has all of the rules about how shareholders should act, as well as the steps for buying and selling shares. 

Unanimous shareholder agreement

A unanimous shareholder agreement has clauses about corporate governance as well as clauses about how shareholders should act and buy-sell agreements. 

The Basics of a Shareholders Agreement

A shareholders agreement's objective is to protect shareholder rights and establish their obligations. It includes sections on how the company's shares will be priced if an existing shareholder wishes to exit. It also offers safeguards for minority stockholders. The agreement gives shareholders the power to decide when and how outsiders can buy shares in the company.

In general, it includes a capitalization table that specifies each shareholder's percentage of ownership, as well as the total number of shares issued by the firm, any restrictions on transferring shares, and how the buy-sell agreement will be funded.

Top 5 Scenarios to Plan for in a Shareholders Agreement

When setting up a shareholders agreement, ensure it provides a fair compensation while protecting the right of the remaining shareholders to acquire the shares of the withdrawing partner. 

Some ways to do this include:

Forced withdrawal

In certain situations, it may be beneficial to force a shareholder to give up their stake in the company. For example, if a shareholder declares bankruptcy or is imprisoned, then the remaining shareholders may want the problematic shareholder to leave the company. However, forcing a shareholder to withdraw is an option that should be used only in rare circumstances. 

A shareholders’ agreement should clearly list:

• the situations in which a problematic shareholder can be asked to withdraw from the business
• how such situations will be handled. 

Shotgun clause

It is a mechanism used for forcing a shareholder to buy out a partner’s stake in the business or sell their shares.

Let's see an example: 

• Shareholder A offers to buy Shareholder B’s stake in the company for a certain price per share
• Shareholder B has two options: to either sell their shares to shareholder A at the offered price or buy shareholder A’s share at that price

The shotgun clause helps shareholders end their relationship relatively easily and effectively. 

Death

This clause allows the remaining shareholders to buy out the shares of a deceased partner. This, in turn, prevents the deceased partner’s heirs from gaining ownership in the company and paves the way for a smooth business transition following the death of a shareholder.

The shareholders' agreement may say that the company has to buy a life insurance policy on each shareholder so that there will be money to buy the shares of a partner who has died. 

Third-party acquisition

This clause lays out instructions for third-party acquisitions. This may include getting acquired or merging with another company.

How Does a Shareholders’ Agreement Protect Minority Shareholders?

A shareholders’ agreement is set up to protect all shareholders, but it is perhaps even more important for minority shareholders. A shareholders’ agreement may ensure minority partners have a say in the most important matters by including a provision that certain decisions can be made only if all partners agree. Examples include: 

• acquiring new funds for the business
• removal or appointment of directors
• a new issue or class of shares 

It is also common for a shareholders’ agreement to include the tag-along or piggyback clause to protect minority shareholders in the event of a third party buying out a majority shareholder.

The clause states that minority shareholders can sell their shares at the same price per share and terms as a majority shareholder. It ensures minority shareholders are able to sell their shares at a fair price if they are not comfortable with the new co-owner. 

Should My Business Get a Shareholders Agreement?

A shareholders' agreement is a legal document that specifies what the shareholders of a company can and cannot do. The absence of a shareholders' agreement, or a poorly written one, may increase the likelihood of future conflict between different shareholders. Even if you are fortunate enough to avoid disagreements with your co-owners, finding a solution that is acceptable to all parties can be time-consuming and costly.

With a shareholder agreement, you can prepare for potential contentious situations in advance. It also provides a forum for resolving disputes should an issue arise in the future. The time and money you will spend on drafting a shareholders’ agreement is worth it since it ensures the smooth running of business operations. Contact our team for more information today.