Business Law

Shareholders Agreements 101

May 22nd, 2015

By Alwynn Gillett

You are thinking of partnering up in a new or existing business venture and are considering incorporating a company. Besides the basic questions as to who will be the shareholders and in what proportion as well as the identity of directors and officers and their respective roles, you may want to consider a Shareholders Agreement to set out the basic rules of your partnership arrangement. Shares of a private corporation usually have restrictions on their transfer so that not just anyone can become a shareholder.

Some of the basic provisions of a Shareholders Agreement that should be considered are as follows:

1. Roles

As an owner, should you be guaranteed a seat on the board of directors.  If you are a minority owner, then there is no guarantee unless you secure a right to a director seat in the shareholders agreement. You may want to include specific roles and responsibilities within the corporation and describe your remuneration.  If a shareholder should become incapacitated or cease working, should their shares be purchased at a pre-agreed value.  This is recommended when ownership is dependent on a shareholder working in the corporation.

2. Start Up Capital

The Shareholders Agreement may deal with the initial capital that will be required to start the business.  Decisions need to be made as to what amount, if any, would be required and who would contribute such amounts whether as a loan or capital.  Going forward, if the corporation requires funds, there could be an attempt to borrow from a bank failing which shareholders must equally contribute in accordance with their ownership proportion.  There may be repercussions if a shareholder does not contribute.  Either the partner who does contribute receives extra interest (ex. 12% per annum) or the partner who did not contribute may be diluted (their ownership interest would be reduced).

3. Sale of shares following death

It is common to provide that on the death of one of the shareholders, their shares would be purchased for a pre-agreed value.  This value can be book value (which tends to be low) or, an agreed value based on a formula such as a multiple of earnings.  We often suggest that inexpensive term life insurance be purchased by the Corporation on the lives of the shareholders (which effectively guarantees a certain amount be paid to the deceased shareholder’s family on death).

4. Life Insurance

Usually cheap term insurance is purchased on the lives of the partners who work in the business.  Upon a death, this insurance is used to buy the shares from the estate.  These provisions also state that the insurance must be used in accordance with the agreement and cannot be used for other purposes.

5. Right of First Refusal

Generally in a private company shareholders are not allowed to sell their shares without the consent of either the directors or shareholders.  Sometimes it is provided that should a partner find a willing third party to purchase said shares and they would like to sell their shares to such person, they first allow the other partners to buy the shares at such price and on such terms and conditions as were negotiated.  Failing exercise of this right of first refusal the partner is then allowed to sell their shares to such third party. The down side is that the partner who does not buy the shares (and exercise the right of first refusal) then ends up with a new partner.

6. Shotgun clause

This clause is the ultimate divorce mechanism.  This provision works best when there are two equal 50/50 shareholders of equal means.  Basically one shareholder makes an offer to buy out the other shareholder who is then allowed to either accept such offer and sell their shares or turn around and buy the shares of the first shareholder at the same price and on the same terms and conditions.  This mechanism ensures that the price is fair as the partner “pulling the trigger” does not know if they are buying or selling at that price.  At the end of the exercise, there is only one shareholder.

Shareholders Agreement are often used in connection with estate planning and wills can be prepared at the same time.  Proper planning is always recommended and we are happy to consult on these issues and prepare any documents to ensure a smooth partnership and successful business venture.

Alwynn Gillett is a commercial lawyer at Spiegel Sohmer with extensive experience in corporate and real estate matters.