In the dynamic world of business, it might be advantageous for certain corporations to have multiple shareholders. Shareholders can contribute with diverse expertise, capital, and resources that assist with the growth and success of the business. However, a well-drafted shareholders agreement is essential to establish and maintain a harmonious relationship among shareholders and protect the interests of all parties involved.
What is a Shareholders Agreement?
A shareholder’s agreement is a legally binding contract that outlines the rights, responsibilities, and obligations of shareholders or shareholder-employees in a corporation. It serves as a comprehensive set of rules that govern the relationship between shareholders, the management of the company, and the protection of their respective interests. The agreement can be tailored to address the unique needs of the business and its shareholders, making it a vital document for any company with multiple shareholders.
These agreements can take on different forms, ranging from comprehensive documents that address a wide range of issues to more focused agreements tailored for specific purposes. In general, there are two primary types of shareholder agreements: general shareholders agreements and unanimous shareholder agreements.
Important Provisions to Include in a Shareholder Agreement
Shareholder agreements can establish clear terms for shareholders to exit the business and transfer their interests. For any business culture or corporation of a closely connected nature, a share transfer is a significant event. Therefore, it might be important for certain businesses to have flexible provisions that strike a balance between the corporation’s interests and those of individual shareholders. Some of these important provisions relating to transfer of shares are as follows:
Shareholders have the opportunity to specify important issues concerning the management and operation of the corporation. By doing so, they can proactively shape the direction of the corporation. Alternatively, if these issues are not explicitly defined, the responsibility for managing the corporation will fall solely on the Board of Directors. Especially for a shareholder who wishes to take an active role in making crucial decisions for the corporation.
Right of First Refusal
This provision allows existing shareholders to purchase shares that another shareholder intends to sell before those shares are offered to external third parties. This is a protective measure that allows shareholders to maintain their percentage ownership and protects them from undesirable shareholders. It is often used in situations where existing shareholders or business partners want to retain control over ownership or to prevent undesirable outside investors from gaining significant influence in the company.
A pre-emptive right is a right that is granted to existing shareholders in a corporation, allowing them to purchase newly issued stock before it becomes available to others. This right is designed to safeguard current shareholders from any potential dilution in the value or control of their shares. Shareholders who buy these shares before they are sold to third parties can maintain their percentage share in the corporation.
These rights serve as protection for minority shareholders when a majority shareholder intends to sell their shares to a third party. When a majority shareholder receives an offer to sell their shares to an external party, the piggyback right allows minority shareholders to “piggyback” or join the transaction and sell their shares as well. Due to their nature, they often discourage shareholders from actively seeking alternative purchasers for their shares.
Drag Along Rights
Shareholders (majority shareholders) who have drag-along rights have the authority to force other shareholders (minority) to sell their shares to a third party making an offer. This right allows them to “drag along” or require minority shareholders to participate in the sale on the same terms and conditions in case the majority shareholders receive a favorable offer from a third party to sell the company.
A shotgun clause, also known as a “buy-sell” clause grants a shareholder the authority to propose an offer to other shareholders for either purchasing their shares at a certain price and terms or selling all his/her own shares. These clauses are commonly utilized as an exit strategy for shareholders who no longer wish to remain in the company, especially in situations where relationships among shareholders have deteriorated.
A non-solicitation clause prohibits shareholders from enticing others to depart from the corporation and engage in competition against it. This clause is common practice and the purpose behind this provision is to prevent shareholders from soliciting employees.
A non-compete clause is a common practice, restricting shareholders from engaging in or starting a business that competes with the company during the term of the agreement or for a specified period after they cease to be shareholders. The purpose of this clause is to protect the company’s interests by preventing shareholders from using the company’s confidential information, trade secrets, or client base to establish a competing enterprise. A non-compete clause should be specific in time and spatial limits.
Unlike publicly traded companies with share values that are easier to determine, private corporations benefit from having a valuation clause for various reasons. In shareholders’ agreements, there is typically a provision that outlines specific valuation methods to be employed when shares are transferred. This essential clause outlines the precise method for calculating the share’s worth, becoming crucial when shareholders intend to sell their shares or in the event of a shareholder’s passing, where the other shareholders may wish to purchase those shares or retirement, disability of a shareholder etc.
In the intricate landscape of corporate governance, shareholder agreements play a pivotal role in defining the relationships among shareholders, protecting their interests, and safeguarding the corporation’s stability. By addressing critical aspects such as share transfers, dispute resolution, and decision-making, these agreements create a framework for the successful operation of a corporation with multiple stakeholders. Given the importance of shareholders agreements, it is advisable for businesses to consult legal professionals.
If you are seeking a shareholder agreements lawyer, to draft comprehensive and effective agreements that align with your unique requirements, contact us today.
The information provided above is of a general nature and should not be considered legal advice. Every transaction or circumstance is unique, and obtaining specific legal advice is necessary to address your particular requirements. Therefore, if you have any legal questions, it is recommended that you consult with a lawyer.