What is a shareholder agreement?

When two or more individuals start or own a corporation together, there are many risks and unforeseen situations that can occur. Therefore, it is common for corporations to have some sort of document which outlines the relationship between the owners (also known as shareholders), governs what happens in various situations, and thereby manages many risks. This document is commonly referred to as a shareholder’s agreement. There are two main types of agreements: a general shareholders agreement and a unanimous shareholders agreement. We will only be looking at the former.

Resolving Disputes

One way shareholder agreements mitigate risk is by creating mechanisms for resolving disputes between the partners. This usually involves the use of systems like negotiation or mediation. One of the most important things the shareholder’s agreement does is to provide a mechanism to value the shares itself. Some of the common methods include, having periodic meetings between the shareholders in order to agree on the price, calculating the price of shares via a formula or algorithm, or even determination of the value by a third party.

Voting Power

These documents deal with a wide variety of issues and, because there is no strict statutory requirement about what needs to be in the agreement, their terms will vary based on the context of the business. For example, one common topic of general agreements includes the governance of the company. If the business is made of equal partners, the agreement may require that many decisions be unanimous. On the other hand, if the business includes venture capitalists or other institutional investors, those parties will be less interested in the day to day operations, and hence would want a unanimous consensus only for major decisions. The governance section usually also consists of a mechanism for making amendments to the shareholder’s agreement.

Restrictions on Transferring Shares

Another topic involves restrictions around selling shares, which can prevent shares from being transferred to unknown or undesirable people. Since this is a fundamental event for any company, almost all shareholder agreements have certain clauses dealing with this. One common clause is called the ‘right of first offer’. This requires the shareholder, who wants to sell their shares, to first make an offer to sell to the existing shareholders. Another common one is called the ‘right of first refusal’. This requires the shareholder, who wants to sell, to first obtain a good faith offer from a third party. The selling shareholder must then take the same offer with the same terms to the other shareholders, and if those other partner refuse, the sale to the third party can occur. An interesting situation can arise here, namely that the third party becomes a ‘stalking horse’. This basically means that third party gets used as leverage to obtain a better deal from the original shareholders. Owners of companies know this tactic, hence they usually put clauses that mitigate the risk of this occurring.

Another common clause is called the ‘shotgun clause’. This allows a shareholder to make an offer to the other shareholders to purchase their shares for a certain price per share; if they refuse the offer, they must buy his shares for the same price per share.

How can Cowan & Carter help you in preparing a shareholder’s agreement?

The experienced team at Cowan & Carter can schedule a consultation with you and the other shareholders to carefully discuss the situation at hand and understand the goals and concerns of the shareholders.

We can the draft a shareholder’s agreement to suit you and ensure the success of your business.

DISCLAIMER: Please note this article is not legal advice. Always consult a lawyer for legal advice regarding your particular situation. The article is not necessarily a complete and accurate picture of the law – it is an article of a general nature.

Published on February 15, 2021