An Introduction To Shareholder Agreements

A party becomes a shareholder in a corporation when shares are issued to them from the corporation in exchange for money paid, property transferred, or past services rendered to the corporation. Shares can also be acquired through purchasing existing shares from another shareholder, as long as this complies with applicable securities laws.

Shareholders hold certain rights, powers, and duties such as:

  • Election of Directors
  • Right to Receive Financial Statements
  • Right to Appoint Auditors
  • Approval of Fundamental Changes
  • Submission of Proposals at Meetings if they have voting power

Shareholder Agreements

There are risks and benefits to be aware of when establishing a new business or potentially investing in an existing corporation. Parties considering these ventures should create a contract to minimize risks and maintain the benefits.

 

A shareholder agreement is a typical contract for corporations with more than one shareholder manage these risks. There are several elements in shareholder agreements; however, they will vary depending on the individual needs. There is broad scope in negotiating and drafting a shareholder agreement. A shareholder agreement can potentially outline how the parties of the corporation will operate and how important decisions will be made.

What are the benefits of a Shareholders Agreetment?

The main advantage of a Shareholder Agreement is that it typically contains provisions in two main areas: decision making and share transfers, which are particularly helpful in the case of deadlocks or an undexpected shift in share ownership as a result, for example, of the banruptcy or death of a shareholder. The Process of establishing a Shareholder Agreement can also be incredibly beneficial, particularlyduring the initial stages of organizing the company, as it defines expectations and creates provisions which will ideally prevent length, expensive, and potentially damaging disputes in the future.

What provisions are usually included in a Shareholder Agreement?

When one shareholder owns majority shares in a coporation, it is important to solidify in a contract what decisions are not to be decided by a simple majority vote. A company’s Shareholder Agreement can identify “a class of material decisions which require a supra-majority and/or unanimous shareholder approval to ensure that the majority stakeholder is not able to make unilateral decisions without first obtaining the consent of the other stakeholders involved.”

Share Transfer: Most Shareholder Agreements require that share transfers are contingent upon the receiver becoming a party to the Shareholder Agreement. Additional provisions under this rule may include:

  • Right of First Refusal: Existing shareholders get first crack at the chance to match a bona fide offer that a shareholder receives from a third-party to purchase his or her shares thus, potentially, preventing a third-party purchaser from becoming a shareholder if it is deemed not in the interest of the company.
  • “Shot Gun” Provisions: This provision is especially useful in the event that relationships between shareholders deteriorate, and one party wishes to exit. It allows a shareholder to establish the terms and price under which he or she is prepared to either sell his or her own shares or purhcase shares from another shareholder. Based on the terms and conditions presented, the other shareholders decide whether or not to buy the offered shares or sell their own shares, depening on the situation.
  • “Piggyback” or “Tag-along” Provision: In the event that a shareholder chooses (and is able) to sell shares to a third-party, this provision gives other shareholders the opportunity to include their shares in the agreement with the third-party buyer, essentially allowing those additional shareholders the opportunity to ‘tag along’ and exit the corporation.
  • “Drag-along” Provision: This provision precents minority shareholders from blocking a potential sale of the company should a majority shareholder wish to exit the corporation. Essentially it ensures that if a majority shareholder decides to sell his or her shares, minority shareholders will be required to sell their shares to the buyer as well.

Dispute Resolution: This is an important aspect to include in you Shareholder Agreement. Potential resolution measures may include mediation or the assignment of a tiebreaking cote or veto to an individual shareholder over certain actions.

Capital Requirements: At different stages of a corporation’s existence, access to funding will be important. A Shareholder Agreement can establish how capital is obtained and prescribe penalties should shareholders fail to contribute the requisite amount based on their interests in the corporation. A Shareholder Agreement can also determine how liability will be shared and how guarantees will be signed should the need for debt financing ever arise.

If you have any questions on whether you need a shareholders’ agreement or would like to discuss your corporate organization, please feel free to contact Leon Efraim at Leon@thomasefraimllp.com by phone at 905-576-5666.

“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique, and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.”


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