The Importance of Shareholders' Agreement
Should you ever invest in a company as a minority investor without a shareholders’ agreement? In our view, the clear answer is no, unless you are agreeable to your money being spent in any way that the majority shareholder thinks best, with little ability to influence getting repaid or getting a return on your investment.
Should you, as a majority shareholder, ever agree to the corporation issuing shares to new shareholders without insisting they sign a shareholders’ agreement? Our view is that an agreement is needed to ensure that you have the ability to control the shares of the company; otherwise you have no ability to stop a transfer of shares to a competitor or other undesirable shareholder. It also will allow you to force the others to sell their shares if the business is to be sold.
Why Business Owners Need a Shareholders’ Agreement
When there is more than one shareholder of the business, the shareholders may have different visions of how the business should be run day-to-day, and what matters should be discussed and approved by not only the directors but by the shareholders as well. They may also have different views on when it is time to bring in new investors or, conversely, sell their investment in the business.
If you have shares in a business, you likely will not find a buyer for the business even if you own more than half the shares unless the buyer can buy the whole business. Without a shareholders’ agreement, there is no way to force the minority shareholders to sell. Conversely, if someone else owns more than 50% of the shares in your business, they can, in the absence of a shareholders’ agreement, appoint all of the directors and, through the directors, effectively control 100% of the way in which business is done, who gets paid what and whether or not dividends are ever paid on the shares you own.
More generally, a shareholders’ agreement helps co-owners discuss how their business will be run and financed and under what circumstances they may exit – all good things to discuss BEFORE investing.
Some people may say that two old friends or a parent and child who own a business together do not need such an agreement. In our experience, having a shareholders’ agreement has, time and time again, proven helpful in providing an agreed-upon framework for friends and family to work out their issues before they become relationship-ending issues.
What does a Shareholders’ Agreement Deal With?
Under corporate law, the shareholders have the power to appoint the directors but it is the directors who decide who will run the business, how much to pay employees, what expenditures the company will make, what business strategy to follow and whether or not dividends will be paid on the shares.
Without a shareholders’ agreement, if you are a minority shareholder, you do not have enough shares to determine who will be appointed to the board of directors. You have no right to determine the day-to-day running of the business or how your investment will be spent. You have no right to get your money back. You have no right to receive dividends or other return on your investment.
The directors are appointed by shareholders holding a majority of the shares, so a minority shareholder has no legal right (short of the other shareholders or the board of directors acting “oppressively”) to appoint anyone to the board, to provide input into its operation, or whether dividends are declared.
A shareholders’ agreement gives the shareholders more power over their investment.
By entering into a shareholders’ agreement, the shareholders can, by contract, set out how the business is to be run.
Some of the common matters dealt with in a shareholders’ agreement include:
Removal of the powers of the board of directors – sometimes the shareholders find it useful to just do away with a board and assume all of the powers and obligations that would otherwise be those of the directors
If there is to be a board of directors, the shareholders can agree on who will be appointed to the board
Which day-to-day and material events require approval of the shareholders in addition to the board of directors, such as letting in new investors, hiring officers, spending above a certain amount on key budget items, taking out loans, giving guarantees, setting salaries for key personnel
Which material events should require unanimous approval of the shareholders or a level of approval over simple majority
A prohibition on any shareholder selling their shares without first offering them to the existing shareholders and a requirement that any new shareholder must be bound by the shareholders’ agreement
A prohibition on a shareholder giving their shares as security to a lender who may otherwise end up as one of the shareholders of the corporation
Establishing situations where a shareholder has the right or obligation to sell their shares, and the corporation and other shareholders have the right or obligation to buy, such as on death, disability, bankruptcy, or leaving the company; or when the majority shareholder wants to be able to sell the whole company to a buyer
Whether or not the shareholders have the right to compete against the company as current shareholders or for some period after they cease to be shareholders
Dispute Resolution – are disputes resolved in the court, or in some sort of binding arbitration?