Four Good Reasons Why Your Company Needs a Shareholder Agreement

Image by Gerd Altmann from Pixabay

Every business partnership, no matter how good the relationship, has the potential to end in dispute. So long as the parties agree on significant matters, minor disagreements generally resolve themselves. The best and most proactive way to attempt to resolve or avoid potential conflicts and to minimize the costs involved in conflict resolution is to have a Shareholder Agreement in place to deal with significant business issues before they arise.

A Shareholder Agreement generally defines the terms of the business relationship between the shareholders, determines how the directors will be elected and how they will conduct themselves, how the business will be run, and how the relationship will end if a shareholder wants to get out of the business or wants to acquire the interest of the other shareholders.

It is important at the outset of any business relationship to consider all factors that may affect the ongoing operations of the business. This type of contingency planning can save a great deal of trouble down the road in the event that shareholders decide they want to pursue different opportunities, or if they disagree on operational issues, suffer financial or personal setbacks, or generally encounter some other circumstance which may alter their ability or willingness to continue the business relationship. A Shareholder Agreement should address all of these issues.

1. Termination of the Business

There are many reasons why a business relationship might be terminated. Early retirement, sudden death or disability, differences of opinion regarding the operations of the business, personality conflicts, financial difficulties, bankruptcy, marital breakdown, etc. are all possibilities. Your company's Shareholder Agreement can establish how these issues will be dealt with if they arise. It can set out the process for a buyout of one partner by another, determine the purchase price of the shares, arrange for the sale and purchase of shares of a deceased or disabled shareholder, and determine how shares can be offered for sale to third parties. It is also extremely important to set out in your Shareholder Agreement a process for dispute resolution, such as mediation or arbitration.

2. Funding Company Operations

Since many small business shareholders finance their own businesses, it is crucial that the Shareholder Agreement set out the obligations that shareholders have regarding cash injections. The agreement should establish whether the shareholders must inject capital themselves or grant personal guarantees when required – and the consequences for any shareholder's failure to do so. The Shareholder Agreement should clearly establish how shareholder loans will be repaid, terms of repayment, interest rate (if any), and whether shareholders holding certain classes of shares will be repaid in priority to others.

3. Setting Limits and Restrictions

The Shareholder Agreement generally deals with issues of management. The voting percentage thresholds that must consent for the business to borrow money, issue shares, change share capital, grant security, hire and fire employees can all be dealt with in the Agreement. In the event that the partners have disproportionate interests in the company, the Shareholder Agreement could also allow for disproportionate representation in management, i.e. the number of directors appointed as nominees of each shareholder.

It is also advisable to clarify everyone’s understanding on the issues of confidentiality and non–competition, in order to restrict any shareholder leaving the business from disclosing confidential or proprietary business information or from participating in the business of a competitor for a specific period of time after they leave. You may also wish to consider dealing with such matters as restrictions on shareholder investments, outside business interests and disclosure obligations to fellow shareholders.

4. Protection from Creditors and Others

You decided who your partners were going to be when you set up your business. But divorce, creditor collection issues, and death can all affect the status quo. The Shareholder Agreement can provide a mechanism to allow for the purchase of shares from a bankrupt or insolvent shareholder, and mitigate against the shares being seized, attached or claimed by any third party.