A Shareholder Agreement, sometimes referred to as a Stockholder Agreement, is a document used to specify the rights and regulations of shareholders in a corporation. It encompasses information such as shareholder details, management decisions, share valuation and information, and more.
A company is owned by its shareholders who, in turn, appoint a board of directors and officers. The person (or persons) who have more than 50% of the voting shares determine who the directors and officers will be. These officers and directors will then run the company. A Shareholders Agreement is essential in giving minority shareholders certain rights and in defining how a company will be governed.
The shareholders appoint the directors who then appoint the management. The directors are the “soul” and conscience of the company.
Management may or may not be liable for company actions. Often these roles are assumed by the same individuals but as a company grows and becomes larger, this may not be the case. When a company is created, its founding shareholders determine how a company will be owned and managed. This takes the form of a “Shareholders Agreement”. As new shareholders enter the picture, for example angel investors, they will want to become part of the agreement and they will most likely add additional complexity. For example, they may want to impose vesting terms and mechanisms to ensure that they ultimately can exit and get a return on their investment. Not having such an agreement can lead to serious problems and disputes and can result in corporate failure. It’s a bit like a prenuptial agreement.
Companies must comply with the law. Companies are incorporated in a particular jurisdiction (e.g. State, Province or Country) and must adhere to the applicable legislation. This legislation lays out the ground rules for corporate governance – what you can and cannot do, e.g. who can be a director? can a company issue shares? how can you buy or sell shares? etc. When a company is formed, it files a Memorandum and Articles of Incorporation (depending on jurisdiction) which are public documents filed with the Registrar of Companies. Typically, a shareholder’s agreement is confidential, and its contents need not be filed or made public.
When a company is formed, its shareholders may decide on a set of ground rules over and above the basic legislation that will govern their behavior. For example, how do you handle a shareholder who wants “out” (and sell her shares)? Should it be possible to “force” (i.e. buyout) a shareholder? How are disagreements handled? Who gets to sit on the Board? What authority is given to whom for various decision-making activities? Can a shareholder (i.e. company founder) be fired? And so on…
A company which is wholly owned by one person need not have such an agreement. However, as soon as there is more than one owner, such an agreement is essential. The spirit of such an agreement will depend on what type of company is contemplated. For example, a three-owner retail shop may adopt a totally different approach to that of a high-tech venture which may have many owners.
Before jumping into a shareholders’ agreement, some very careful thought must be given to the share ownership. Who owns how many shares (and for what contribution – cash? time? intellectual property, etc)? And, how are these shares held? This is the time to talk to tax experts about some serious personal tax planning. Too many entrepreneurs ignore this important facet of owning shares only to find that when they “cash in”, they have a major tax headache. One should consider the merits of using Family trusts or issuing shares to one’s spouse and children. How is share ownership (and subsequent selling) treated by the tax authorities? Is there a disadvantage to granting stock options to employees versus giving shares (with possible vesting provisions) to them instead?
Some of the main points (ie. a checklist) to include in a shareholders’ agreement are:
After drafting an agreement, it is a good idea to ask a few key questions to ensure that the agreement will in fact be useful. Ask yourself the following:
Preparing and discussing such an agreement will give you valuable insights into other parties’ styles, objectives, etc. It should force a close and honest evaluation of who will do what and who is committed to doing what. Most importantly, are the founders’ personal goals, objectives and propensities to take risk compatible? If one founder envisages a small, closely held company as way to be self-employed and another envisages a dynamic, go-for-it enterprise, this marriage won’t work! Even if you’re not sure about certain things and no matter how thorough you are, you will overlook something. Do it, then fix it if necessary, i.e. revise an agreement later rather than defer having one in the first instance.
The legal aspects of company ownership are different from country to country. Therefore, we suggest getting legal advice from the country of company domicile. However, if you would like to draft an agreement, here is a template that might be useful.
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