Do you need a shareholder agreement?

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 that 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. In the event that a shareholder of a corporation disagrees with another shareholder, these mechanisms can be invaluable. One of the most important things the shareholder’s agreement does is provide a mechanism to value the shares itself. Some of the common methods include having periodic meetings between the shareholders 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. This ensures that the rights of shareholders are protected and that shareholders are treated fairly. It is crucial for directors to manage and supervise the management of dispute resolution to ensure smooth business operations.

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 of the corporation 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, giving the power of directors a structured approach to manage the corporation’s affairs.

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 as the other shareholders, and if those other partners refuse, the sale to the third party can occur. This ensures that shareholders can decide whether to accept the offer or not.

An interesting situation can arise here, namely that the third party becomes a ‘stalking horse.’ This basically means that the 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. This ensures the rights of shareholders are protected and that all shareholders are treated fairly.

Another common clause is called the ‘shotgun clause.’ This allows a shareholder to make an offer to the other shareholders to purchase shares for a certain price per share; if they refuse the offer, they must buy his shares for the same price per share. This is crucial in situations where one shareholder wishes to exit the business, as it ensures that the shareholder’s shares are valued appropriately and that the interest in the business is maintained among all the shareholders. This method is particularly useful in the initial stages of a startup, where it is essential to manage the privileges and obligations of shareholders effectively.

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

The experienced team at Cowan & Carter Civil Litigation Toronto firm 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. 

This ensures that the written agreement takes into account the rights and obligations of each shareholder and the operations of the corporation. Our approach to corporate law ensures that we work closely with you to meet your specific needs.

Our litigation firm in Toronto can then draft a shareholder’s agreement to suit you and ensure the success of your business. This agreement will cover the business and affairs of the corporation, the rights of shareholders, and mechanisms to handle the death of a shareholder or the wish to exit. Additionally, it will include important clauses like the drag-along rights, ensuring that the future shareholders and current business owners are protected and that the incorporations are smooth. With this agreement in place, you can be confident that your business will run smoothly and that all shareholders’ rights are protected.

Whether you are dealing with a majority shareholder, resolving issues related to share transfer, or setting up a new startup, Cowan & Carter Law Firm litigation services can help resolve these complexities. Our shareholder agreements constitute legal frameworks that address important aspects of business operations, making it easier for business partners to make decisions and protect their interests.

Published on February 15, 2021