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Understanding Shareholder's Agreements

Shareholder Agreements 101 – What You Need To Know

Businesses can start in all sorts of different ways. Sometimes it’s an idea hastily sketched on a cocktail napkin in the middle of an engaging conversation. Other major corporations have started with a few friends converging in a garage, figuring out how to ‘build a better mousetrap.’ While sometimes businesses succeed by way of sheer luck, almost all businesses at their foundation benefit from a strategic plan for their growth and development.

Yet just as your business needs a plan to succeed, so does your relationship with the others in the business. When two people enter into a business relationship, they are always better served by having some form of a written contract that governs the rules and operation of that relationship. In the case of corporations, a key part of that ‘rulebook’ is known as a shareholder agreement, and the key components within that shareholder agreement can govern your business for years to come.

We often receive questions from business owners about shareholder agreements and wanted to take a moment to provide some helpful answers for our readers.

What is a shareholder agreement?

Think of a shareholder agreement as a contract between you, the other people with an ownership stake in your business, and the business itself. A shareholder agreement governs shareholders, so those with an ownership interest in the business (whether they be co-founders, majority shareholders, or minority shareholders) and determines what they can and cannot do with regard to the business.

If you’re thinking “but there are only a few of us, why would we even need this,” remember that your business will grow and change as it becomes successful. If you start earning significant revenue, your business may attract investors who are seeking to purchase shares in the business. There are also different types of shares available, which can allow investors to become involved in your business in different ways. The shareholder agreement will be what governs their participation.

What types of shareholder agreements are there?

There are two main types of shareholder agreements, and the one that you chose can make a world of difference later on.

A General Shareholder Agreement is a contract between the corporation and the various shareholders within a business. It operates based on the rules of the corporation itself, such as articles and by-laws, as well as established law. It aligns with the structure of the corporation – that shareholders can decide who will be a director of the corporation, and thus control day-to-day operations. For smaller corporations with simple structures, these roles can easily blend together, but it is the shareholders who have the power to determine who governs the corporation.

Alternatively, corporations can operate under a Unanimous Shareholder Agreement. These agreements are signed by, and bind, all shareholders, no matter how much or how little of the company they own. They bind future shareholders as well. They can only be amended by agreement between all the shareholders. These agreements are allowed despite the laws that give directors discretion over the operations of a company. These agreements, therefore, allow shareholders to restrict the powers of directors. Unanimous Shareholder Agreements can be useful in some circumstances, but the requirement for unanimous consent can make it cumbersome when all shareholders must cooperate. If you have a minority shareholder for example who disagrees with the will of the majority, that disagreement can place decision-making in a deadlock.

What goes into a shareholder agreement?

There are several key components contained within most shareholder agreements, including:

Governance and Control – Allowing shareholders the right to determine who runs the day-to-day operations of the corporation. A corporation’s management is ultimately responsible to its shareholders. The shareholder agreement can also outline the roles shareholders will play, and who will be entitled to a seat on the Board of Directors.

Financing – A shareholders agreement can determine what funding the company will require as start-up capital, and who will be responsible for injecting more capital into the company.

Exit Provisions – Eventually shareholders will leave the company, whether through death or through their own departure (voluntary or involuntary). The shareholder agreement should set out what happens to a person’s shares when they leave the company, and how they are valued at the time of their departure.

Restrictive Covenants – These can be crucial in a smaller company when one person’s desire to sell their shares becomes a major event. Shareholder agreements can determine how this must be done, such as a requirement that shares must first be offered to the other shareholders before going to a third party, or the rights of shareholders to purchase shares on the same terms as a third party would. There are several intricate structures that can be implemented to determine how and when shares can be sold.

What happens if we have a disagreement?

When shareholders disagree, a shareholder agreement can serve as the rulebook for how that disagreement is handled. A shareholder agreement can include clauses such as a requirement that any disputes between shareholders are settled privately through arbitration, rather than publicly through litigation. Even without a requirement for arbitration, a shareholder agreement can mandate that mediation is at least attempted to settle a dispute before it heads to the courts. Lastly, as outlined above, a shareholder agreement can determine what steps are to take place if a shareholder does wish to exit the business, and can implement several unique mechanisms that will keep the business operations while their shares are sorted.

Why should our business have a shareholder agreement?

While starting a business is an exciting time full of big ideas, it is always better to do so properly and methodically to ensure long-lasting success. Much like a house, a great structure is built on a solid foundation, and any major gaps in that foundation can lead to significant problems later on.

Having a shareholder agreement in place in the earliest days of your business can eliminate the guesswork of how to work with your shareholders later on. It will let you focus on growth and business development, all while having a solid framework for how your shareholders can best support that growth.

Can Pavey Law help draft a shareholder agreement?

Absolutely! Our corporate lawyers work closely with businesses in the Cambridge, Kitchener, and Waterloo areas on a variety of corporate matters. We would be pleased to speak with you about implementing a shareholder agreement in order to protect your business and its shareholders. Contact us today to set up a consultation with one of our business lawyers.