5 Reasons Why Your Corporation Needs a Shareholder Agreement

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By Marisa Lau and Aaron Grinhaus

Starting a business can be risky, but when you have a dream, a plan and goals, optimism cuts through the anxiety that risk can bring. That optimism though also blinds people to the risks that may come if the business does not work out as planned, especially where a few people get together as shareholders of a corporation to start a business, either as investors or owner-operators. What happens if one of the shareholders wants to sell her or his shares to a third party? What happens if one of the shareholders is getting divorced, and their former spouse becomes entitled to those shares? What happens if there is a dispute among the shareholders and one or more want out? What if more money is needed, who contributes and how much? What happens to the shares of a shareholder who passes away? All of these circumstances, and many more, could result in you inheriting a business partner you did not bargain for. Cue the shareholder agreement.

Having a shareholder agreement is key to ensuring the smooth operation of your corporation, and to dealing with all the issues mentioned above. A shareholder agreement is a contract among the shareholders outlining the rights and responsibilities of each shareholder to the corporation and to each other. This gives the shareholders a clear idea of their expected involvement in the corporation, and how to resolve disputes so that court can be avoided and money can be saved. Here are the top 5 reasons you should negotiate a shareholder agreement before you start doing business:

  1. It’s Confidential: Shareholder Agreements are confidential. In negotiating a shareholder agreement, shareholders can decide which operational decisions require votes of all shareholders. Without such an agreement, voting power would be determined by the governing corporate statutes and by-laws. The agreement can also alleviate the concerns of minority shareholders of not having decision-making power in the corporation by requiring unanimous voting for certain major decisions of the corporation.
  1. Financing: In a shareholder agreement, you can set out how the corporation will be funded, whether it be from institutional lenders or shareholder loans. There can be mechanisms obligating shareholders to contribute to the corporation in the event the corporation is unable to secure institutional funding.
  1. Getting rid of inactive shareholders: You can insert mechanisms in your shareholder agreement to get rid of shareholders who are no longer contributing to the growth of your corporation, or not fulfilling their obligations. This is much more difficult to do when there is no such agreement in place. Terms such as buy-sell (ie “Shotgun”) provisions, sale of shares on death or disability of shareholder and rights of first refusal help you achieve this. Non-compete and non-solicit provisions also ensure these inactive shareholders do not compete with your business for a certain period of time after leaving.
  1. Avoid bringing on unfamiliar shareholders: As a start-up company, you may be wary about working with new shareholders with whom you are not familiar. Without restrictions in place in a shareholder agreement, your shareholders can easily sell their shares to third parties, resulting in you having to make decisions about the corporation with new people. In a shareholder agreement, rights of first refusal provisions can be inserted to ensure that shares are offered to the current shareholders before they are sold to third parties.
  1. Dispute Resolution: A shareholder agreement can include mechanisms to resolve conflicts among shareholders. Without such mechanisms in place, you and your shareholders could be involved in costly litigation.

Grinhaus Law Firm can help guide you through the process of negotiating and drafting the most effective shareholder agreement and corporate structure for your situation. Please call or email us to see how we can help.

PLEASE NOTE: THIS IS NOT INTENDED TO BE LEGAL ADVICE AND SHOULD NOT BE RELIED ON AS SUCH. IT IS IMPORTANT THAT YOU CONSULT WITH A LICENSED PROFESSIONAL.