Do you need a Shareholder Agreement?

Frequently we get a new client that has a great business and is running it with their “best friend.”  They have total alignment and everything is running smoothly and they can’t foresee even the possibility of things not working out perfectly.

We love these clients!  But we hear ominous ticking sounds.  At some point this pollyanna-ish position will change and a dispute will arise.  Having a Shareholders’ Agreement is an absolute necessity when you are doing business with anyone other than your spouse (even then it’s still a good idea, but consult with your family lawyer as well here as local family law may override anything done here).

I always tell people that at some point there will be a disagreement, and it’s much easier to negotiate how you will handle those issues now, while you are still best friends, then when emotions are hot and people are feeling hurt.

A Shareholders’ Agreement is NOT part of the company constitution, rules or articles.  It actually doesn’t have anything formally to do with the company - it is an agreement between the shareholders and binds their actions (with respect to the company) to a pre-determined plan and allows any party to compel another party to act, vote or execute in certain ways.

While the company is not legally bound to such an agreement, it is good practice to have the presence of such agreement minuted in the AGM and Directors’ Meeting (with a copy attached).  This makes it part of the official record.

There are many things that can be included in a Shareholders’ Agreement.  Here are some of the key ones:

• Appointment of Directors: Shareholders appoint Directors by popular vote (>50%).  If there are different groups of shareholders should they all be entitled to appoint one director from each group?  Should each shareholder be entitled to be a Director?  Can a Director be fired and for what cause?  These can be in the company constitution/rules, but having them in the SA is also useful.
• Appointment of Officers: Shareholders typically appoint Non-Executive Officers by popular vote (>50%), which include the roles of Chairperson of the Board, Treasurer & Secretary (these do not need to be separate people but are usually Board Members).   Directors typically appoint Executive roles such as President/CEO, CFO, etc., which do not need to be Board Members (but in smaller closely-held companies these people are often also Board Members as the Board of Directors doubles as the Management Team for the business).  Can non-shareholders be appointed as officers?  Can Officers be removed?
• Dividend Policy: At what point will the company consider paying dividends?  How will you balance the needs of remunerated shareholders (officers and employees) vs. investors?
• Executive Remuneration: How will you determine the salaries paid to executives (most of these are likely to be shareholders and excessive remuneration can reduce the amount available for dividends)?  Will there be bonuses payable?
• Audited Financial Statements:  Will the annual financial statements be audited?  This is usually determined by popular vote at the Annual General Meeting of Shareholders.
• Involvement of family members: Are other family members (including minority or investor shareholders) entitled to work for the company?  Who decides if the founder’s son will really make the best CFO?
• Disability/Reduction in the work of CEO or other shareholder-employees:  What happens when one of the key shareholder-employees is unable (or unwilling) to put in the same level of effort as they did at the beginning (or, is no longer up to the task)?  
• Voting Rights:  Voting rights are usually laid out in the constitution/articles of the company, but further agreements can be made here, including proxy voting agreements.
• Restrictions on Transfer & Default: Can any shareholder sell their shares to anyone?  Do existing shareholders have a first right of refusal?  How will you value the shares?  Can one party or group force a buyout of all other parties?
• Death/disability or a shareholder: What happens to the shares of any shareholder upon their death?  Do you really want to be in business with the spouse or children of a deceased shareholder (their needs will now be different than what you had planned for)?  Is there a forced sale to existing shareholders (or share buy-back)?
• Liquidity: If the business has cash flow troubles who will front the additional cash or guarantee loans?

This list is not exhaustive, but gives you a good idea of some of the issues that you should consider in your Shareholder Agreement BEFORE you encounter problems in your business.