What is a Shareholders Agreement?
A shareholders agreement is a contract among some or all of the shareholders of a corporation. It sets out their rights and responsibilities with respect to the shares they own, and how decisions pertaining to the corporation will be made. The corporation is commonly a party to the agreement, as certain provisions may apply to it.
An agreement among all of the shareholders of a corporation, and which restricts the powers of the directors to manage the affairs of the corporation – generally by allocating such powers to the shareholders – is known as a unanimous shareholder agreement (a “USA”).[1] A USA can, in certain cases, alter the governance arrangements otherwise dictated by corporate law statute, giving the shareholders more flexibility to manage the corporation as they see fit.
Is a Shareholders Agreement necessary? If not, why would I want one?
While a shareholders agreement is optional, it can be critical to governing the relationship among the shareholders and providing certainty as to their rights in various circumstances.
A corporation is subject to its governing legislation, its articles of incorporation, and the corporate by-laws. Such legislation and documentation provide a framework, but do not address many of the circumstances that can arise when two or more people run a business together. This is where a shareholders agreement comes in, by supplementing such legislation and documentation.
For example, if we use the example of a corporation in which the shareholders hold common shares, a shareholders agreement can be helpful in both of the following circumstances:
- Where the shares are owned by two persons, 50/50, a shareholders agreement can include provisions that will address circumstances where there is a deadlock, either by delegating the decision to one party, or by providing a mechanism for one party to buy the other out (which, in the absence of a shareholders agreement, may not be an option); and
- Where there is unequal ownership among shareholders, a shareholders agreement can include provisions for:
- the protection of minority shareholder interests, and/or
- the protection of the majority. For example, a shareholders agreement can be drafted to require a minority shareholder to sell their shares to a third-party buyer that wishes to buy all the shares in the corporation, if the majority wish to accept the offer, thereby overriding a minority shareholder who may otherwise hold up such a transaction.
When Should a Shareholders Agreement be put in place?
Ideally the shareholders agreement will be effective upon incorporation, or as soon as there is more than one shareholder. This allows the parties to agree as to how various circumstances and decisions will be handled at the outset, before any disagreement occurs.
When starting a new business, it is common for founders to be focused on operational aspects such as attracting customers and refining the delivery of products and services. In light of these demands, founders often opt to set up their business using a simplistic legal structure, foregoing a shareholders agreement at the outset with the intention of putting one in place later. The difficulty with this approach is that it may not be feasible for the parties to settle a shareholders agreement if disagreements arise first.
However, even if your business has been operational for decades and is running smoothly, putting a shareholders agreement in place can be beneficial at any time for the purpose of dealing with matters such as the eventual sale of the business or exit rights for individual shareholders.
Common Provisions in Shareholders Agreements Applicable to Small and Medium-Sized Businesses
While not exhaustive, the following list contains some of the important items that can be addressed in a shareholders agreement:
- Director nomination rights
- Voting thresholds for the approval of important decisions such as dividend declarations and large expenditures
- Circumstances in which shares may be transferred, and new shares may be issued
- The approach to be taken if the corporation requires additional capital, either from shareholders or from a bank
- What will happen to a shareholder’s shares if they pass away, are no longer able to be involved in operations, or if they are terminated from employment (and how the purchase price for their shares will be determined in such cases)
- Restrictions on competition with the business of the corporation
- In the event of a breakdown of the relationship between shareholders, a mechanism can be made available requiring one shareholder to sell all their shares to the other (often called a ‘shotgun’ clause)
Conclusion
A shareholders agreement can be a valuable tool to facilitate the smooth operation of the business, and provide a roadmap for governance and transitions that may occur through the life of the business.
In addition to drafting the shareholders agreement, a lawyer can provide insight as to the pros and cons of various approaches based on the nature and structure of the business, the number of shareholders, the issues of concern to the shareholders and the dynamics of the parties.
If you are contemplating putting a shareholders agreement in place for a new or existing business and would like assistance, please contact a member of Pallett Valo’s Business Law group.
[1] Pursuant to the definitions set out in the Canada Business Corporations Act and the Business Corporations Act (Ontario).