3 Reasons For A Shareholders' Agreement

Starting a new business can be a whirlwind. From the moment you come up with a business idea, it seems like there are endless decisions to be made: Where will you set up shop? Who will design your website? What will your marketing strategy be? Who will do your bookkeeping? Will you get a foosball table for your staff lounge? The list goes on and on.

In the midst of all the excitement, many entrepreneurs get caught up in the momentum and put off making important decisions about the legal underpinnings of the business. But if you are going down the path of entrepreneurship with a business partner, there is one decision you can’t afford to put off—a shareholders' agreement.

A shareholders' agreement is a contract between the shareholders of a company. It acts as a supplement to the articles of the company by providing a more detailed framework for how the shareholders interact with each other and with the directors of the company. A solid shareholders' agreement will not only help founders sort out any disagreements that may arise but will also address a number of outside factors that could impact the business' future such as death or disability.

We've compiled some of the main reasons you’ll want to consider a shareholders' agreement for your company.

1. There Will Be Disagreements

When you’re starting up your business, it’s hard to imagine that you and your business partner would ever have a falling out or come to an insurmountable disagreement. But no matter how well you and your partner get along, you will inevitably disagree on something at some point. And it will be a lot harder to agree on a mechanism for resolving your dispute productively when you’re in the thick of it. It is much easier to decide ahead of time what approach you will take if you disagree on a decision.

A well-drafted shareholders' agreement will set out a fair and transparent mechanism for resolving disputes, which can act as a roadmap when dealing with disagreements. For example, your shareholders' agreement can set out a requirement for negotiation or mediation before resorting to an expensive and time-consuming court battle. Or, if the founders reach an absolute deadlock, a shotgun provision in a shareholders' agreement can help them go their separate ways without dissolving the company or resorting to litigation.

The point is: a shareholders' agreement allows the founders to agree on a mechanism for resolving disputes ahead of time. That way, when a disagreement comes up, your shareholders' agreement can help you sort out, and hopefully move past, the dispute and get back to focusing on the business.

2. Death or Disability

What would happen to your business if your partner died or became disabled? Shareholders may not necessarily want to be carrying on business with their business partner’s spouse or children. A shareholders' agreement can help provide a smooth transition when a shareholder is faced with changes in their personal circumstances.

For example, instead of the shares being passed down to the deceased or disabled shareholder’s survivors, it may be preferable to have the company or the other shareholders buyout the shares. The agreement would also address procedural matters such as the method of valuation to be used for the shares.

3. Approval on Important Issues

Founders of a new company may not always hold an equal number of shares. This could result in the majority shareholders having veto power on many decisions. A shareholders’ agreement, however, can set out how particular matters will be voted on.

One way to ensure minority shareholders have a voice on important issues is to require unanimous approval of shareholders for certain decisions (such as entering into loan agreements, the election of directors, or requiring cash contributions from shareholders).

In addition, once a shareholders agreement is in place, it can only be amended with the agreement of all of the shareholders. In contrast, the articles of a company can be changed by a 2/3 or 75% majority (depending on the threshold set out in the articles). So, a shareholders' agreement can be a very effective tool for providing protection for minority shareholders.

Final Thoughts

Before you get too far down the road of a business partnership, you want to make sure you’ve taken the necessary steps to protect yourself and your business. And experience has shown us that the best time to sit down and hash out all of these issues is when everyone is getting along and being reasonable. You don’t want to wait until your business partner is going through a divorce to negotiate what should happen if your business partner is going through a divorce. Business Law doesn't have to be complicated, get in touch with FH&P Lawyers if you're in need of support!