Starting a business is an exciting adventure. When you start a business with other partners, the goal is to combine your resources and efforts to ensure the success of the business. If you are operating your business as a corporation, then the business partners shall be the shareholders, directors, and officers of the corporation.
The success of a business will be highly dependent on the quality of its partners and the relationship between them. Business partners may have different individual interests, but the business can only thrive if all the partners are committed to its success.
A shareholders’ agreement is an excellent tool to ensure the efficient management of the business and the partners’ commitment to the growth and the success of the business.
WHAT IS A SHAREHOLDERS’ AGREEMENT?
A shareholders’ agreement is a contract among the shareholders of a corporation with respect to the management of the corporation as well as the rights and obligations of the shareholders. It is the agreement which manages the relationship between the corporation and the shareholders as well as the relationship between such shareholders.
WHY DO YOU NEED A SHAREHOLDERS’ AGREEMENT?
In this article, we will elaborate on the 3 reasons why you need a shareholders’ agreement for your business:
- Business management: it outlines the rights and obligations of the shareholders with respect to the management of the corporation
- Stability: it helps to ensure long-term stability in the shareholding and the management of the corporation;
- Clarity: it addresses in advance sensitive questions such as the premature exit of the shareholders or their death.
1. BUSINESS MANAGEMENT
A shareholders’ agreement outlines many essential provisions regarding the management of the corporation. Firstly, it sets out the shareholders’ rights to elect the directors of the corporation. For example, when there are 3 shareholders with equal share ownership, each shareholder shall usually be entitled to elect one director of his choice. In this scenario, each shareholder has an equal say in the management of the business.
Then, a shareholders’ agreement also determines the decision-making process of the board of directors (“BOD”) of the corporation. When there are only 2 directors, it is easy to conclude that every decision shall require the unanimous consent of the directors. However, when such is not the case, the shareholders’ agreement usually sets the consent required. Usually, decisions of the BOD require the consent of the majority (50%+1) of the directors, but it can also provide a different consent threshold.
Typical shareholders’ agreements also include a list of reserved matters which shall require the consent of a predetermined percentage of voting shares. These are important decisions regarding the structure or the management of the business, such as changes to the constituting documents of the corporation, the granting of security interests over the assets of the corporation, or any structural change to the corporation such as a merger or an amalgamation. This mechanism is there to ensure that the shareholders get a veto right on certain important decisions of the corporation.
A shareholders’ agreement can also provide information regarding the shareholders’ direct involvement in the affairs of the corporation, which can be relevant when the directors and the shareholders of the corporation are not the same persons. For example, a shareholders’ agreement will have provisions regarding the shareholders’ obligations to finance the company or guarantee the obligations of the corporation when required by the BOD.
2. STABILITY
A shareholders’ agreement usually contains provisions to ensure the long-term stability of the corporation, especially with respect to its shareholding. A typical shareholders’ agreement will stipulate that the shareholders cannot transfer or encumber their shares without the unanimous consent of the shareholders or otherwise complying with the provisions of the agreement. Then, another typical clause is the right of first refusal, which states that any shareholder who wishes to sell his shares must first offer them to the other shareholders before selling them to a third party, and such party must agree to be bound by the terms and conditions of the shareholders’ agreement. You also have the pre-emptive rights clause, which states that any additional shares issued by the BOD shall initially be offered to the existing shareholders before being issued to a third party, and such party must often be pre-approved by all the existing shareholders prior such issuance.
These provisions help to prevent against sudden and often unwanted changes in the shareholding of the corporation, thus creating stability in the operations of the business.
3. CLARITY
Finally, a shareholders’ agreement helps to anticipate sometimes complex situations or events which can affect the long-term viability of the corporation. A typical example would be the death or disability of a shareholder. These situations can potentially cause a lot of turmoil, especially in the absence of a proper mechanism to ensure a smooth transition following such events. The other shareholders may not want to have the heirs of the deceased as shareholders, or the representative of the disabled shareholder making business decisions on behalf of such shareholder. A shareholders’ agreement addresses these issues by providing that upon the occurrence of such events, the corporation (or the existing shareholders, as the case may be) shall have the option to purchase the shares of the deceased or disabled shareholder. It also provides all the relevant details regarding such sale, such as the manner of purchase, the determination of the purchase price as well as its payment, the closing procedures, and any other provisions which will help facilitate the sale of the affected shareholders’ shares.
The same can be said about the forced sale of the shares held by a shareholder upon certain events such as the bankruptcy of the shareholder, such shareholder ceasing to hold his position in the corporation without the consent of the other shareholders, a substantial breach of the provisions of the shareholders’ agreement, or an act or a conduct which brings the corporation into disrepute. Upon the occurrence of any one of such events, a shareholders’ agreement usually provides that the corporation or the remaining shareholders shall have the option to purchase the disavowed shareholder’s shares, usually at a discount which varies depending on the gravity of the triggering event.
These are often difficult situations to deal with, and without a proper exit mechanism, the remaining shareholders may end up stuck with a shareholder who may not have the corporation’s best interests at heart.
A shareholders’ agreement ensures that the shareholders know in advance the different exit mechanisms available to them, whether voluntary or forced. Everybody knows what to expect and this helps to avoid misunderstandings and conflicts.
CONCLUSION
As you can see based on the above, a shareholders’ agreement is an essential tool for the proper management of your business. The right legal foundations from the start shall contribute to the success of your business. Endlex Legal can help you draft a proper shareholders’ agreement to protect the interests of your business.
Information provided in this article is intended as general introductory information only. The information provided in this article is not legal advice. It should not be construed as legal advice and should not be relied upon as such. Should you want legal advice regarding the information provided in this article, please contact one of our lawyers.
