Do you need a shareholders agreement?
Fundamental considerations when going into business with others

Woodbridge corporate and securities lawyer, Joseph Chiummiento, of Core Lawyers, offers insight on the merit of shareholders’ agreements.

Every shareholders agreement has some very standard considerations to think about and discuss when going into business with others.

What is a Shareholders Agreement?

Simply stated, it is an agreement between two or more people about how to operate and make decisions about your business.

Do we need a Shareholders Agreement?

There is no requirement in law that a company’s shareholders have to enter into an agreement. However, the main reason shareholders agreements are used is to ensure everyone is clear on matters of control, decision making, voting rights, exits and buyouts on death, termination or divorce. A well-crafted shareholders agreement can avoid strenuous and costly legal battles down the road.

Key considerations in a shareholders agreement

There is a wide variance in shareholders agreements but the key concepts are the same in all of them, whether short or long. They include:

1. The Shotgun Provision – a right to offer to buy someone’s shares or sell yours at a set price (that person having a right to buy or sell their shares at that price).  Or will you set an exit formula using a valuation of some kind?  What about buyout on death or disability – is the valuation reduced by the proportionate ownership of the deceased or disabled person?  Will payments be lump sum or over time? – The belief is that everyone should contribute to the corporation building value, and if they are not able to then the value is reduced; however, there may not be readily funds to buy out as a lump sum.  These clauses are put in place to help determine how to procedurally move forward when someone exits.

2. Non-competition terms – meaning the leaving shareholder won’t compete in the business if the other shareholders buy one shareholder or more out. This is usually agreed upon for a set period and a set geographic area i.e. southern Ontario. Non-compete terms of a shareholders agreement are generally more readily enforced by courts and should be well thought out before signing.

3. Non-solicitation terms – meaning a shareholder who leaves the company will not solicit employees or clients of the company or the other shareholders.  These types of “promises” to do or not do something are important in protecting the goodwill, brand and development value of the business.

4. Financing terms – if running an operating line of credit banks will want you all to personally guarantee the full amount, so the shareholder agreement would or could say the liability will be pro rata to your shareholdings.  Banks will go after everyone but only collect against the shareholder(s) who have money first.  This means that shareholders would have to go after the other shareholders for their proportionate share and would rightfully be empowered to do so under a shareholders agreement.  Every shareholder will have 100% liability for financing from a bank.

5. Specialty items – what happens in a situation of divorce of one of the shareholders?  Can a divorcing spouse of a shareholder become a shareholder?  How will the shares be valued for purposes of the divorce?  What type of information must the divorcing shareholder provide to his/her spouse?  Other specialty items to consider include imposing a moratorium on any buy/sell provisions for 1, 2, 3 or more years to give the business a chance to grow etc.

6. Decision making – are decisions going to be made by a simple majority (51%), or by a special majority (66 2/3rds %), or unanimous (100%) among the shareholders.

7. Insurance – does the company want to purchase life insurance for the shareholders so that, in the case of a shareholder passing, the insurance is used to buy out that person’s shares from their estate?  How about key man insurance which covers one or two main people in the business usually considered the business drivers. Should something happen to them the entire business could be at jeopardy.

These are a good starting points to consider. An initial step would also be to speak to someone who has been through it, has had shareholders or helped other shareholder such as an accountant or a corporate lawyer. These professionals can provide you with guidance on the best matters to include in a shareholders agreement for your business.

If you have any questions about shareholder agreements or wish to discuss your individual situation please feel free to contact me directly.