What is a Shareholders’ Agreement?
A Shareholders’ Agreement is first and foremost a contract between the owners of a company. This agreement is often referred to as a prenuptial agreement for businesses since it defines how disputes will be resolved and adds rules for company management and ownership structure. In a Shareholders’ Agreement, directors and shareholders have decision-making powers, restrictions on the sale and transfer of shares, and dispute resolution procedures.
You won’t have to worry about a Shareholders’ Agreement if you’re the only owner of your company.
Why does your business need a Shareholders’ Agreement?
1) Decision making and disputes
Starting a business can be smooth sailing if you and your partners are confident about the future. Small businesses can easily fail due to shareholder disputes, which are inevitable in business. In a Shareholders’ Agreement, you can specify dispute resolution mechanisms in advance and decide proactively how to resolve specific issues.
Furthermore, the laws governing corporations in Canada grant extensive powers to directors. There are some companies in which this legal default situation is satisfactory, and the directors are able to make all the important decisions for the company. Other companies, especially small and growing companies, prefer shareholder decision-making without relying on directors. These decision-making functions can be transferred from directors to shareholders through a Shareholders’ Agreement.
2) Controlling the transfer of shares to new owners
Your partners and you probably have a good understanding of your relationship as you start your company. As your business grows and you consider adding new owners, things can change. Any change to your team can have a huge impact on your entire organization.
Think about the effect it would have on your business if your partners were free to transfer their shares to anyone they wished. Suddenly, someone you don’t know could be making decisions alongside you for your company.
Therefore, Shareholders’ Agreements often restrict the transfer of shares. Shareholder restrictions can include requiring all shareholders to consent before any one of them sells shares and providing existing shareholders agreement with an opportunity to purchase shares of departing shareholders.
What happens if one of your partners leaves the company. Are partners able to buy each other out?
A buy-sell clause or a shotgun clause in a shareholders agreement can be used for this purpose. This structure allows one partner to buy the shares of a partner who wishes to leave the company, with all terms pre-negotiated to avoid disputes. This type of dispute may lead to litigation or even the dissolution of the company without a shotgun clause.
Relationship building with your partners
Even the process of creating a Shareholders’ Agreement can benefit your business, since it forces you and your partners to have an open and honest dialog about topics that might otherwise go unspoken for years. When you realize your team is on the same page and if a conflict arises, you’ve already taken the necessary steps to resolve it fairly and equitably, you’ll feel stronger.
Legal jargon and terms you’ll find in a Shareholders’ Agreement
Shareholders’ Agreements contain a lot of unique terminology. The following are the most common terms:
Once the majority shareholders agree to sell the company, Drag Along Right requires minority shareholders to sell their shares.
By requiring any offer to purchase shares from the majority shareholders to be made to all minority shareholders as well, piggyback right is the opposite of a drag along right. Minority shareholders could then sell their shares to the buyer. Also called a tag-along right.
As a result of the Put Clause, shareholders can ask the company at any time to buy back their shares from them. Alternatively, it’s called a ‘Buy-Back’ clause.
A non-compete clause prohibits shareholders from being involved with one of the company’s direct competitors for a set period of time.
A Non-Solicitation Clause prevents a shareholder from soliciting the business’s clients or employees.
In the event that one shareholder receives an offer to sell their shares, all other existing shareholders have the opportunity to match that offer.
As opposed to a Right of First Refusal clause, a Right of First Offer clause stipulates that a shareholder who wishes to sell their shares must first offer those shares to existing shareholders at a specific price. As long as the original offer is equal to or higher than the price of the shares, the shareholder is free to sell to anyone after no other existing shareholders buy the shares.
Under the Shotgun Clause, one shareholder may sell their shares and leave the company or require the remaining shareholders to purchase their shares. Shareholders can set a price for the company’s shares, and then either sell their shares at the set price or purchase the shares of the shareholder who set the price.