What is a Shareholder Agreement and Why Do You Need One?
A shareholder agreement is an important contractual document between the shareholders of a company. It ensures that the management of the company and the responsibilities and obligations of the shareholders are properly laid out, so that there is certainty about what can and cannot be done. It provides a mechanism to deal with various situations, and sets out the principles by which the shareholders plan on running the business. It can provide greater protections for minority shareholders, and quickly aid in the resolution of disputes. Ultimately, these agreements reduce the possibility of conflicts between shareholders.
While there is no statutory requirement for a company to have a shareholder’s agreement in place, it is highly recommended for any company with more than one shareholder to have one; it is virtually essential when there is no majority shareholder. While it may be far from people’s minds when starting a business, it is best to have one in place from the outset, before any disagreements put strain on the running of the company.
Let’s look at some scenarios.
What happens if a shareholder dies, and the shares pass to their spouse, who may be unfamiliar with the operation of the business?
A shareholder agreement could ensure that those shares revert back to the company upon the shareholder’s death.
What about if a shareholder sells their shares to a competitor of the company?
A shareholder’s agreement can restrict how and to whom shares are sold or transferred.
What about if a shareholder is no longer actively involved in the business and the other shareholders want to buy their shares back?
A shareholder agreement can set out under what circumstances a shareholder can be required to sell their shares.
What are some important things covered by a shareholders agreement?
Governance: Unless laid out in a shareholders agreement, the general management of a company is usually determined by the directors, and only certain key decisions are required to be made by the shareholders. A shareholders agreement can make it clear who is to make decisions, and how they are to be made; the powers of directors can be restricted or expanded depending on the needs of the company.
Dispute Resolution: Sometimes situations arise in which the shareholders cannot reach consensus; having a dispute resolution procedure in place will outline the procedures to be followed for a successful resolution.
Issuing and Transferring Shares: In addition to setting out a method to determine the fair market value of shares, a shareholder agreement can outline how to bring in new shareholders into the company, either through the issuance of new shares, or the sale of existing ones. It will also establish how shares are to be transferred in the event that a shareholder wishes to leave the company, or if one shareholder wants to buy another out. It can also prevent the unintentional transfer of shares, following a death, accident or bankruptcy of a shareholder.
Profits and Losses: A shareholder agreement can outline when and how profits are distributed amongst the shareholders, how liabilities are borne, or how shareholders are obligated to contribute additional investments.
Non-Competition: Restrictions can be placed on shareholders in terms of them getting involved with competing companies, or setting up companies of their own.
A shareholder’s agreement is an invaluable tool that sets up the procedural framework necessary to govern the internal management of a company; it establishes a way to manage the future success of a company. It is an affordable means of preventing problems or disputes down the road during the life of the company.
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Disclaimer: This blog post is meant as general information only and does not constitute legal advice. Please contact Winright if you have questions or concerns around this topic.