A shareholder agreement is a written agreement between shareholders, which sets out shareholder rights, protections, and obligations; the method by which shares will be valued; and how the corporation and its business will be structured, managed, and operated. A shareholder agreement can ensure that shareholders are treated fairly and can minimize disagreements by clarifying how certain matters will be dealt with and how disputes will be resolved if they arise. Every corporation with more than one shareholder should have a shareholder agreement.
Types of Shareholder Agreements
There are two different types of shareholder agreements:
- general shareholder agreements, which bind only the shareholders who sign them; and
- unanimous shareholder agreements, which bind all shareholders, present and future, with or without their signatures, as long as they have been notified that the agreement exists.
Parties to an Agreement
There may also be other parties to a (unanimous) shareholder agreement, in addition to shareholders, such as principals of corporate shareholders and the corporation itself. Principals of corporate shareholders may be added as parties to a (unanimous) shareholder agreement that treats individual shareholders and principals of corporate shareholders identically in situations like death, disability, and bankruptcy. A corporation should be a party to a (unanimous) shareholder agreement that contains promises from the shareholders to the corporation (i.e. confidentiality and non-competition covenants) and/or obligations of the corporation to its shareholders (i.e. to repurchase shares in the event of death or disability).
Potential issues between shareholders
Shareholders who are concerned about upfront cost, are eager to begin operations, or who are closely related, may choose not to enter into a shareholder agreement. However, it is important to remember that relationships evolve over time and that spending some money at the outset may save you more money in the long run, as there is always a risk of disputes in business. Even if shareholders start out on the same page, unexpected issues may arise, for example:
- shareholders might discover that they have different management styles, or a shareholder may end up being excluded from participating in management;
- two shareholders may no longer get along and desire a method of pushing one or the other out of the company;
- one shareholder may wish to take the business in a new direction;
- founding family members may end up at odds due to emotional baggage;
- a marriage might end, and a shareholders’ spouse might claim entitlement to his/her shares;
- a shareholder might pass away, and a new shareholder might enter the company by inheritance;
- a shareholder might become insolvent;
- shareholders with more votes might decide to gang up on those with fewer votes;
- a shareholder might begin to feel that other shareholders are being paid more than they deserve; or
- there might be a general breakdown in communication.
A well-drafted shareholder agreement can anticipate these and other potential issues and describe how they would be handled, significantly reducing the risk of lengthy disputes and costly litigation.
Overall, the upfront cost of having a lawyer prepare a (unanimous) shareholder agreement at the beginning will almost always be less than the cost of hiring litigators and navigating court proceedings after disputes arise, and the peace of mind that comes from being on the same page and putting those terms on paper at the outset (just in case) is priceless. It is also much simpler to come to an agreement when things are amicable at the start-up of a company than further down the road when the business and the relationships of those who run it become more complicated.
Stay tuned for more information on the core terms of a (unanimous) shareholder agreement and on methods of protecting minority shareholders.
Contact Jade Renaud at email@example.com with any questions relating to this or any other business law question.