Four Benefits of a Shareholders’ Agreement

By Mark D. Hazlett

Last month, I wrote about some of the pros and cons of incorporating. If you have taken the plunge and have incorporated a business with multiple shareholders (or are about to), then an important next consideration is whether you should get a Shareholders’ Agreement. The answer, as always, depends on the circumstances; but the following is intended to be a primer on why it may be a good idea for you to consider one.

A Shareholders’ Agreement, generally speaking, takes powers away from the board of directors of a corporation and causes it to be more directly run by the shareholders. They also usually provide a framework for how to deal with a variety of situations that may arise over the “lifespan” of a business.

A common reason that businesses fail is because of disputes between shareholders. A well-drafted Shareholders’ Agreement will limit these disputes and provide a cost-effective method of problem-solving. That way, owners can spend their time and money running a successful business. One way to think of a Shareholders’ Agreement is as almost like a pre-nuptial agreement for your business – it’s best to make important decisions about the future of your company while everyone is on the same page, and before any disagreement arises.

With that being said, there is no statutory obligation for a shareholder in a corporation to enter into an agreement. It follows that the content of the agreement can be flexible and customized to the needs and desires of the shareholders and the business.

Benefits of a Shareholders’ Agreement

There are four main benefits to having a Shareholders’ Agreement.

1. Clarity: A Shareholders’ Agreement describes how a corporation should be operated and outlines shareholder rights and obligations.[1] The agreement can also be used to define the management roles within the organization, such as the board of directors and their operations. This can be important to avoid future confusion on the parties’ intended roles.
   
   
2. Decision Making: Without a Shareholders’ Agreement, shareholder input is generally limited to electing directors, amending the Articles of Incorporation, and to consulting financial statements. A Shareholders’ Agreement can be used to expand shareholder voting rights or alter the voting requirements for various decisions. Typically, within corporations, a simple majority vote (51%) is all that is required to make a decision. Decisions regarding the fundamental aspects of a corporation require a “special majority” which amounts to two-thirds (66.67%) of the votes. A Shareholders’ Agreement can increase the percentage of votes required to seventy-five percent (75%) or even unanimous agreement, for instance, to increase minority shareholder protection from the majority’s ability to make changes to the fundamental business of the corporation.
   
   
3. Dispute Resolution: The disputes that cause the most damage to businesses are often those that arise between shareholders. A Shareholders’ Agreement can outline several mechanisms for dispute resolution. For example, the agreement could contain a provision mandating that the parties negotiate in the presence of a mediator before commencing public proceedings or that disputes be resolved in private arbitration rather than public and costly litigation.
   
   Another popular dispute resolution mechanism is the Shotgun Clause, otherwise known as the Buy-Sell Agreement. This clause provides shareholders with a means of exiting the corporation. The clause operates by forcing a partner into either buying-out an offering partner or selling their shares to the offering partner under the proposed terms. The clause may be engaged with a shareholder offering to buy the shares of other partners at a specific price. The target shareholders can then either accept the offer and sell their shares, or they must buy out the originating shareholder at the specified price.[2]
   
   These kinds of provisions can allow a path forward for the corporation where it can efficiently deal with disputes, rather than dragging the entire business through a potentially long and protracted battle between shareholders who no longer see eye-to-eye.
   
   
4. Predictability: Finally, a Shareholders’ Agreement dictates how a corporation is to deal with foreseeable and unforeseeable future events, and outlines how the corporation is permitted to grow and evolve.

Several such provisions the agreement could include are:

• How a corporation will go about accessing capital and financing;
• Share transfer restrictions between key members of the organization;
• What happens when a shareholder dies or is otherwise incapacitated;
• A put right to allow a shareholder or group of shareholders to be bought out after a condition has been met;
• A call right to allow a shareholder or group of shareholders to buy out another after a condition has been met; and
• Mechanisms for the valuation of shares and discounts or bonuses for compulsory sales depending on the circumstances.

These kinds of provisions all help to chart a more predictable course for the future life of the corporation by making key choices now, while all of the shareholders are on the same page.

For further information regarding shareholders’ agreements or other business law needs, please reach out to Mark Hazlett at mhazlett@sorbaralaw.com.