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What is a shareholder agreement?
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Table of Contents
What Is A Shareholder Agreement
A shareholder agreement is an arrangement between shareholders of a corporation that defines the shareholders’ rights and obligations.
The primary purpose of creating a shareholder agreement is to ensure that the company shareholders define the rights and obligations of the corporation.
A shareholder agreement can include many provisions such as voting rights, buyback provisions, non-compete obligations, and so on.
A shareholder is not legally required but it’s a good idea for companies having many shareholders that are also actively engaged in the business to put one in place.
In most cases, whenever a corporation has more than two shareholders, a shareholder agreement is used to ensure that all the shareholders have the same understanding of their rights and obligations.
The idea is to include terms and conditions allowing the shareholders to successfully manage the company, determine how shares are issued, bought, and sold, and how decisions are made within the company.
Why Have A Shareholder Agreement
Here are the primary reasons why creating a shareholder agreement is a good idea.
Sale of Shares
When a shareholder wants to sell their stocks, it’s important to follow a precise mechanism to avoid disputes.
A shareholder agreement can allow the company or other stockholders to have a right of first refusal over shares.
This mechanism is commonly used to control who can acquire shares in the corporation.
This control is beneficial, especially for small companies that want the primary shareholders to retain the stocks rather than sell them to third parties.
A shareholder agreement is an excellent tool for providing business security in case of a dispute.
It provides the basic rules governing potential disputes.
This is favorable for investors who are looking to invest in a company.
When a company has specific steps for dealing with disputes, shareholders know how the company will act, as this might include mediation, arbitrator, etc.
Employment of Shareholders
It’s common for key employees to own shares.
That’s why it’s vital to have a shareholder agreement to outline the link between shareholding and employment.
Suppose a director or employee resigns, are they forced to sell their shares?
Or can they keep hold of their shares to receive the company’s benefit?
A shareholder agreement is the best tool to specify what happens to the stocks if they stop to be employed in the company.
A shareholder agreement is useful for the shareholders to define their rights within the corporation.
In certain cases, shareholders can provide specific protections for minority shareholders or agree on specific rights to be granted to a specific class of shares.
The shareholder agreement is the best way to agree on how dividends should be paid out.
Having the proper rules and mechanics agreed up and in place will make it easier for the company to make dividend payouts without causing any disputes among the shareholders.
When To Draft A Shareholder Agreement
The best time to create a shareholder agreement is when the company is newly established or shortly thereafter.
However, it’s possible to draft and execute one at any time.
For simple agreements, in a short period of time, the shareholders can reach an agreement on its most important terms.
If a company starts operating for too long and then intends to implement a shareholder agreement, it may be more challenging as the shareholders may already have internal “issues” or differences that may affect the proper negotiation of the document.
It’s best to consult with a qualified attorney to know what provisions to include in the shareholder agreement and have them prepare it according to the right standards.
How Shareholder Agreements Work
Shareholders’ agreements are tools that offer protection against disputes, conflicts, and unforeseen circumstances with investors, directors, co-founders, etc.
The idea is to implement an agreement where the shareholders can resolve potential causes of dispute.
A shareholder agreement is a flexible document where the shareholders can include terms and conditions that are important to them.
For instance, a shareholder who is also a key employee may be required to sell his or her shares by leaving the company’s employment.
Alternatively, shareholders may be required to sign non-competition clauses, non-solicitation, and confidentiality clauses to ensure that the company is protected.
Shareholder agreements are legally enforceable.
As a result, should a shareholder fail to respect his or her obligations in the shareholder agreement, the non-breaching shareholders or corporation can file a lawsuit against the breaching shareholder seeking a remedy.
Remedies such as injunctive reliefs, compensatory damages, or even liquidated damages may be sought in court.
Shareholder Agreement Features
Every shareholder agreement is unique.
The information in the private contract depends on the size, number of holders, the company’s nature, and types of shares.
Here are a few elements that could be found in a shareholder agreement.
Usually, a shareholder agreement includes the number of shares each party owns.
This is important to ensure that each shareholder is attributed the right percentage of ownership in the corporation.
The percentage of shares owned by each shareholder is important as it will dictate how many votes each shareholder can cast in different shareholder meetings, how much dividend is paid to the shareholder, and so on.
Another important element of a shareholder agreement is the manner the shareholders will vote.
Typically, company founders will want to be on the board of the corporation.
As a result, the shareholders may agree to have their votes cast in such a way that certain shareholders are elected as members of the board.
Purchase And Sale of Shares
Shareholders’ agreements typically include terms and conditions on how stockholders can sell, buy, and transfer shares.
Typically, private companies will include restrictions on the sale and transfer of shares to ensure they do not trigger disclosure requirements under the securities laws.
For example, shareholders can agree that a shareholder leaving the company should give other holders the opportunity of buying their shares before offering them to someone external.
Usually, shareholder agreements include non-compete provisions where a shareholder undertakes not to compete with the corporation for a given period of time.
The idea is to prevent a shareholder from acquiring business contacts, knowledge, and relationships to leave the company and start a competing business.
In essence, it prevents a shareholder from leaving the company and taking customers, suppliers, and employees away.
Sometimes disputes resolutions can end in deadlocks.
This usually occurs when shareholders cannot get a majority or unanimous consent.
A shareholder agreement can outline what establishes a deadlock and the steps to follow when this condition occurs.
Each deadlock resolution clause carries a different significance.
You can also have other provisions such as:
- Life insurance requirements
- Shot-gun clause
- Setting of a price per share
- Right of first refusal
- Drag along clause
- Tag along clause
- Minority shareholder protection
- Arbitration clause
- Procedures for calling meetings
Shareholder Agreement vs Partnership Agreement
Is a shareholder agreement the same thing as a partnership agreement?
No, they’re not the same.
A partnership agreement is a document among partners in a partnership.
In contrast, a shareholder agreement is an agreement between the stockholders of a corporation.
A partnership is when at least two or more individuals get together to run a business in the form of a partnership such as a general partnership, limited partnership, or limited liability partnership.
In a partnership, the partners work together and share the profit and loss.
A partnership agreement outlines the rights and obligations of each partner within the partnership and dictates how someone can become a partner or leave the partnership.
On the other hand, shareholders are individuals who possess stocks in a corporation (such as an S-Corporation or C-Corporation.
Shareholders have the right to vote in important company matters, receive dividends, and the residual proceeds of the business when it is fully liquidated.
A corporation can be formed with one or more shareholders.
Shareholders are not required to manage the company on a daily basis.
However, a stockholder can be the company’s director and manage the day-to-day business.
A shareholder agreement is an agreement that is signed when a corporation has two or more shareholders and where they wish to define the rules by which they hold stock in the corporation.
So there you have it folks!
What is a shareholder agreement?
In a nutshell, a shareholder agreement is an agreement between shareholders of a corporation where they agree on how the company should be operated along with their rights and obligations.
A typical startup shareholder agreement contains elements such as mandatory buy-back provisions, first right of refusal, procedures for selling the shares, how the share price is determined, life insurance requirements, and so on.
Shareholder agreements are legally binding contracts and are highly useful for startups and companies with a growing shareholder base.
Now that you know what a shareholder agreement is all about and how it works, good luck with your research!
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