Why Do I Need A Shareholders' Agreement?

If you are doing business with anyone, it is strongly recommended that you put in place an agreement that specifies how important decisions will be made.  In a corporation, this type of agreement is called a shareholders’ agreement.

What Is A Shareholders’ Agreement?

In corporate law, the directors of a corporation make decisions for the company until they delegate that decision-making power to someone else.  However, a shareholders’ agreement can restrict the powers of the directors to manage the business and affairs of the corporation by giving certain powers to the shareholders.  Without a shareholders’ agreement, the ability of the shareholders to control a private company is generally limited to their power to elect and dismiss the directors.

A shareholders’ agreement is an agreement among the owners (shareholders) of a corporation.  It sets out how certain decisions are made, what thresholds need to be met for a decision to become binding, and how shareholders join and leave the company.  Companies whose owners are less involved in the day-to-day operations of a business benefit from a framework for making major decisions.  Even companies in which all of the owners manage the business can benefit from a written agreement setting out how to deal with decision-making.

What Can A Shareholders’ Agreement Do For You?

A shareholders’ agreement can be a useful tool in a variety of different situations, including:

  • Owners entering and exiting the business:

    • Although no one starts a business relationship thinking about how it will end, a shareholders’ agreement provides the framework for how an owner can leave the business. Shareholders can decide on which mechanisms they would like to include in the agreement – rights of first refusal on new shares being issued, “shotgun” clauses to allow for the forced buying or selling of shares when the relationship is no longer working, or “drag along/tag along” rights for when a major change in ownership is being planned.

  • Decision-making thresholds:

    • Most shareholders’ agreements include a list of decision-making thresholds that must be met for a decision to become binding. Some include different levels of approval for different kinds of decisions (for example, 50% of the shareholders need to approve certain spending limits and 2/3 of the shareholders need to approve borrowing funds over a certain dollar amount). This can give some control to owners who are not as actively involved in the day-to-day operations of the business.

  • Minority shareholder protection:

    • Where one or more shareholders holds a majority of the company’s shares, the minority shareholder(s) may want to ensure that their interests are protected.  The shareholders’ agreement can provide for the minority shareholder(s) to have a minimum number of seats on the board of directors in order to participate in important decisions in the same way as the majority shareholder(s).

  • Providing for different classes of shareholders:

    • Where the company’s shareholders represent a number of different and possibly conflicting interests, such as investors, employees and founding owners, the shareholders’ agreement may provide different voting mechanisms and levels of participation to protect their separate interests.

  • Succession planning with a family owned business:

    • A shareholders’ agreement can help provide a framework for a company transitioning between generations. For example, it may provide the original owner with continuing control of the company even when her family members have collectively surpassed her voting power through the shares issued to them. The shareholders’ agreement may also be crafted to give the original owner the right to appoint a majority of the company’s directors or veto certain company decisions, such as the declaration of dividends or issuance of shares. It may also give her the right to receive sufficient funds to retire on by requiring the other shareholders or the company to purchase or redeem her shares over time, in accordance with a series of prescribed dates or milestones. The possibilities are vast.

  • Employee shareholders:

    • If the business has employee shareholders, a shareholders’ agreement can be used to address what happens to their shares in the event that they cease to be employees. For example, they may be required to sell their shares back to the company or to the other shareholders at a specified price.  The shareholders’ agreement may also restrict the employees from having any rights to veto a company decision.

Why Are Shareholders’ Agreements Important?

Regardless of the many different situations in which a shareholders’ agreement is useful, it is usually put into place to avoid disputes in the future, such as the removal or addition of shareholders, disputes relating to control and management of the business, financing the business and conflicts of interests, and the abuse of power by the majority shareholder(s).  A clear shareholders’ agreement can help avoid the costs incurred as a result of any business disruption when resolving disputes.

How Momentum Can Help

If you’re starting up, then we can help you determine whether a shareholders’ agreement is right for your business and craft a shareholders’ agreement that meets your specific commercial needs.

If you’re an existing company, then we can guide you through the process of negotiating shareholders’ agreements. We are happy to help deal you with shareholder disputes and to guide the shareholders’ agreement resolution process.

Finally, if you’re an individual shareholder, then we can provide independent legal advice to you as you navigate your governing shareholders’ agreement.