Starting a Business with Some Business Partners? You May Need a Shareholder Agreement!

When you start a business, you’re probably not giving too much thought to formal corporate structures. Instead your focus is on seeking funding, figuring out your supply chain, and thinking about how you can build this business in your earlier stages. A shareholders agreement may be the last thing on your mind.

Yet as your business grows and becomes successful, you will have interest from investors who will become shareholders in that business. They’ll be glad to support your business, but in turn they’ll be asking for a portion of ownership in that business.

So how do you make sure that your shareholders get what they need? How do you outline their role in the company, and the responsibilities that come with owning those shares? How do you resolve any disputes that may come up between them?

The answer is a shareholders agreement. While it may not be top of your mind on Day 1 of your business, it is a great way to protect your business as it grows.

What is a shareholder agreement?

The shareholder agreement is the official contract that binds shareholders, or those who have an ownership stake in the business. Think of it as a contract between yourself as an owner, any other co-owners of the business, any shareholders who own a portion of the business from afar, and the business itself.

Shareholders are not a one-size-fits-all scenario. There may be majority shareholders who have a large portion of the business (who may be involved in day-to-day management or may be silent behind the scenes), along with minority shareholders who only hold a small portion of the business but who still have rights.

Even if your business is still small, and has no external shareholders besides the co-founders, it’s still wise to set up a shareholders agreement earlier rather than later. Shareholders will want a piece of the business as it becomes successful, and a shareholders agreement is what will govern their role within the business.

What types of shareholder agreements are there?

There are two primary types of shareholders agreements to be aware of – General Shareholder Agreements, and Unanimous Shareholder Agreements.

General Shareholder Agreements are agreements that broadly oversee the role of shareholders within the business. They operate based on the rules of the corporation itself (think corporate by-laws, etc.), as well as established corporate law. Shareholders can appoint the directors who run the governance of the corporation, and even in a small corporation where these rules overlap, these sorts of agreements can still be the right fit.

Unanimous Shareholders Agreements work differently. With these agreements, all shareholders need to agree before any decision takes effect, and these decisions can even override corporate governance provided everyone is on the same page. These agreements may be right in some circumstances, but they can be problematic if shareholders do not see eye-to-eye, which can then bring decision-making to a standstill.

What goes into a shareholder agreement?

Shareholder agreements are what guide the actions of shareholders, and thus contain some key components. These include:

  • Governance and Control – in a corporation, it’s the shareholders that ultimately wield control as they are the ones who can vote in a Board of Directors to run the day-to-day operations. Shareholders determine who is in charge, and how money will be injected into the corporation to keep the operations going.
  • Exit Provisions – Sometimes shareholders leave a company. Shareholders may pass on, they may leave to pursue other interests, or they may have a dispute with fellow shareholders that ends badly. Exit provisions can determine what happens when shareholders leave (and how they can be removed), and what happens to their shares upon their departure.
  • Restrictive Covenants – What are shareholders not allowed to do? If they want to sell their shares, should they be required to offer them to other shareholders before going to a third-party? There are multiple restrictions that can be placed on shareholders, and these can be especially important in the early days of the business as key players come and go.

What happens if there is a dispute between shareholders?

Shareholders may not always agree with each other, and in the case of unanimous shareholders agreements it can be that lone dissenting voice that holds up all progress! Yet no matter what type of agreement is in place, what happens when shareholders ultimately cannot come to a consensus?

If a dispute arises, a shareholders agreement can spell out the steps for resolving that dispute. For example, it can include an arbitration clause, which confirms that any disputes between shareholders must be settled through private arbitration. This can keep disputes out of the courts and, sometimes just as importantly, out of the headlines.

If a shareholder does want to leave the business, the shareholders agreement can speak to this as well. Having a clear procedure for departing shareholders and redistribution of those shares can save tremendous headaches vs. creating patchwork arrangements with unpredictable results.

Final Thoughts

While a shareholders agreement may not seem like your top priority, you should ensure that it is high on the list. Don’t be caught unprepared when investors come knocking! Having an agreement gives you the opportunity to write the rules, and it can protect your operations in case any disputes arise down the line.

Our corporate and commercial lawyers regularly draft shareholders agreements for all sizes of businesses. We’re also happy to review them, so that you know your rights as an older or shareholder in case any questions arise. Contact us today to set up a consultation.