Business ventures can be operated through a number of structures and today more and more businesses are being operated through a company. Shareholder Agreements can be a key tool in the ongoing management of the company and the company’s businesses.
Often at the commencement of a new business venture, shareholders may feel that there is no need for a Shareholder Agreement. There is an air of euphoria surrounding the new venture and the shareholders couldn’t possibly imagine the need for such an agreement when all of the parties get on sowell.
When in fact, the fact that the shareholders do get along so well makes it the perfect time to discuss and put in place a Shareholder Agreement. Many times we are asked to prepare a Shareholder Agreement for a company that has been trading for a number of years and the request is generally as a result of a disagreement between the shareholders. This makes it extremely difficult for the shareholders to agree on the terms to be included in the Shareholder Agreement.
So what exactly is a Shareholder Agreement? A Shareholder Agreement is an agreement between the shareholders of a company describing how the company should be operated and the shareholders’ rights and obligations. It is a document that can be tailored to suit the requirements of the shareholders and the company, “one size does not fit all” and it is important that each of the shareholders turn their minds to the various scenarios that could play out in the company’s future.
The following are some key considerations for shareholders considering a Shareholder Agreement:
- What if one of the shareholders wishes to sell their shares?
- What if one of the shareholders become incapacitated and are no longer able to work in the company’s business?
- What if one of the shareholders dies?
- What amount of effort are each of the shareholders required to put into the operation of the company’s business?
- Can new shareholders (often employees) be brought into the company?
- What are the insurance requirements of the company?
In the event that one of the shareholders leaves a company, whether because of a desire to leave the business or the necessity to do so, it is important that the Shareholder Agreement sets out the means by which that shareholder can leave. For example, does the company buyback the shares, does the continuing shareholders buy the shares, is the shareholder entitled to transfer the shares to a third party?
Depending on the means by which the shareholder must leave the company, the tax implications for the shareholder, company and continuing shareholders can vary greatly. It is for this reason that it is highly desirable for the involvement of the company’s and shareholders’ accountants from the outset.
Usually, continuing shareholders will be given the first option to purchase the outgoing shareholders shares prior to the shares being offered for sale to a third party. It may be, that in the event that one shareholder wishes to leave the company, that the company must be wound up.
Another common provision is come along tag along options to sell. These provisions set out a mechanism to deal with the situation where there is an offer to purchase the whole of the company from an outside party and some but not all of the shareholders wish to accept the offer.
There are several options and once again, what is right for one company will not be appropriate for another. We also encourage our clients to set a method of valuation for the shares in the Shareholders Agreement. This avoids the difficulties faced in trying to agree on the value of the shares when the shareholders are no longer getting along with each other, or where a shareholder has become disabled or deceased. Obviously, in the event of a dispute, shareholders will have competing interests, therefore, shareholders should where possible, agree up front on the value of the enterprise and how that value is to be reviewed annually, or set out a formula in the Shareholder Agreement by which the value will be calculated.
When drafting the Shareholder Agreement, the shareholders should give consideration to what life and disability insurances each of the shareholders should have how the proceeds from those policies should be applied.
Generally the level of insurance will depend on the shareholder’s involvement in the Company, and whether a shareholder may be required to finance the acquisition of another shareholder’s shares.
Some shareholders believe that it is important to have cross ownership of life and disability insurance of the individuals working in the company’s business. We always try to encourage our clients to put aside some time each week or month where shareholders can meet and work on the strategic issues of the company’s business and discuss any issues which may be of concern to shareholders. It is better to address issues early rather than let them fester. This can be difficult where shareholders are situated in various locations.
Lastly, a Shareholder Agreement is not something that should be prepared, put in the bottom drawer and forgotten. A Shareholder Agreement may grow and change with the company and should be reviewed whenever the company’s operations change, a shareholder leaves, or a new shareholder joins the company.
