Shareholder Agreement

A Shareholder Agreement governs the rights and duties between shareholders, as shareholders, employees and also potential creditors of the corporation. Set out below is a short list of some of the points to be considered:

1. Share Structure.

This sets out who gets how many shares of which class. It should also contain restrictions on the ability of the corporation to amend the share structure without the consent of a stipulated majority of the shareholders. It should also provide a "preemptive" right on the issuance of new shares. This means that if the corporation decides to issue new shares to raise capital, it would first have to offer them to the existing shareholders in the proportion that they hold shares.

2. Employment of Shareholders

If shareholders are going to be employees of the corporation, it is common to set out their duties and compensation, either in the Shareholder Agreement or in separate employment contracts. The agreement should cover such things as the right to be employed, minimum/maximum salaries, bonuses, and whether an employee has to devote his full time and attention to the business or can have outside interests, (and whether these can be competing interests). Getting the employment terms nailed down is particularly important for a minority shareholder who is leaving some other position to work for the corporation.

3. Non-Arms Length Transactions

The corporation may be having business dealings with you individually, or through other corporations, on a non-arms length business. This might include purchase of assets, lease of property, etc. It is wise to anticipate this and get approval of all shareholders in advance and, if appropriate, get consent in advance that any directors or shareholders dealing with the corporation will be entitled to do so on normal commercial terms - ie: to make a normal profit from doing so with the corporation (if this is, in fact, what is intended). This avoids problems of conflict of interest and breach of fiduciary obligation later on.

4. Decision Making

Normally, day-to-day decision-making is conducted by the directors through the their appointed officers. Normally, a simply majority of votes at the meeting of the board of directors will be sufficient to make a decision. Should some decisions require one hundred percent consent? Examples might be such things as selling the business, taking on new corporate debt, going into a new business, hiring and firing major employees, paying dividends and bonuses, etc. We would caution, however, that having a one hundred percent consent requirement allows any one shareholder to essentially frustrate the activities of the corporation.

5. Finance

It should be set out what the parties' intentions are for financing the corporation:

Will shareholders be required to advance monies to the corporation as shareholder loan for operating capital?

Will they all be required to contribute equally?

What if the corporation needs further monies at a later date?

Will personal guarantees of bank loans be required?

We suggest that these issues be addressed. In addition, we suggest an indemnity clause so that if any shareholder has to come up with more than his percentage of money, for either operating purposes or as a result of guarantees being called, the other shareholders will contribute so that the losses are shared equally. In addition, shareholder agreements sometimes provide that if the corporation needs money and some shareholders are not able to contribute their share, this would give rise to the right of the other shareholders to buy out the shareholder that does not contribute.

6. Buy-Sell Provisions

It is normal for a shareholder agreement to provide for either an option or an obligation for the other shareholders of the corporation to buy out the shareholder who dies, goes into bankruptcy, resigns from actual employment or becomes disabled. These options sometimes also exist where a shareholder refuses to sign a guarantee or refuses to inject his share of capital, etc.

Sometimes these kind of buy-sell provisions call for an immediate cash payment, including repayment of all shareholder loans and release of any guarantees. In other cases, especially where the shares have become quite valuable, and the buyout is permitted to proceed over time. For example, terms of two to five years are not uncommon, with interest payable in the interim, and certain restrictions on what can be done with the corporation until the payout is completed.

7. Valuation

If there are buy-sell provisions, it is important to have some kind of procedure for valuing shares. Some Shareholder agreements have "shotgun" clauses, allowing the party who initiates the buy-sell to name a price, and give the other shareholders the choice to either buy or sell their shares at that price per share. We don't consider this particularly fair, because the parties may not all be in the same financial position and this could permit a well-off shareholder to buy out the others at a discount. We recommend that any buyouts proceed of the basis of either a valuation done by a qualified valuator or on the basis of a formula related to the financial statements of the business, such as, commonly, a multiple of the company's annual earnings. In other cases, the shareholders agree to sit down once a year and value the shares. This valuation would then be binding until the next annual meeting.

8. Transfer Restrictions

Most corporations require some kind of restriction on transfer of shares and certainly it is in the interest of each of you to want to be able to control who your partners are. Obviously, how much control you have over your partners will effect how much control they have over you.

In some cases there are no transfers permitted without the everybody being in agreement.

In other cases a transfer is permitted as long as there is a consent of the majority of the shareholders.

Another option is a right of first refusal, so that if you want to transfer shares, you may do so as long as you first offer the shares on the same terms to the other shareholders proportionately to their shareholdings.

Another popular option is a "come-along" provision, so that a shareholder can only sell his shares to a third party, if he also produces an offer from that third party to buy all the shares at the same price. The other shareholders can then decide whether to come-along with the offer or end up with a new partner.

These articles are provided as general information only, and should not be considered to be legal advice. For advice on a specific situation, please see one of our lawyers.

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