Doing Business With A Family or Friend? There's A Shareholder's Agreement for That.
Updated: May 11
It is not uncommon for two friends to start a new business together. The same goes for family-owned businesses. In fact, in Canada the majority of businesses are family-owned. Operating a business with your best friend or a family member seems like a good idea, until its not. The risk is that many people do not realize that just because your relationship works well in a family or friendship setting, does not always mean it will work well in a business setting.
What is a Shareholders’ Agreement?
A shareholders’ agreement governs the activities of the shareholders (as in, what they can and cannot do). There are two different types of shareholders’ agreements: a general shareholders’ agreement and a unanimous shareholders’ agreement (“USA”). A general shareholders’ agreement is subject to the articles and by-laws of the company as well as the provisions of the corporate statute that governs the company. A USA involves each shareholder of the company and must be signed by each one.
Depending on the parties and the nature of their relationship, shareholders’ agreements can serve various purposes. Where two shareholders are equal partners, for example, unanimity between both parties may work best; whereas silent investors may want to be less involved in the daily management of the company, yet still wish to retain veto over key management decisions – such as a shift in the vision of the business, change of control, or other restructuring initiatives.
Shareholders’ agreements also determine procedural tasks with respect to the business. A shareholders’ agreement can determine how a board meeting is to be called; how often such board meetings take place; and quorum thresholds. The by-laws of the business and the shareholders’ agreement should be also reviewed in tandem to ensure they do not conflict.
When do you need a Shareholder’s Agreement?
A shareholders’ agreement is a contract between some or all of the shareholders of a company. Typically, you need a shareholder agreement:
When you have more than one stakeholder in the business (whether friend, family, or business partner) and need to lay out the terms and conditions governing your relationship in the business
When you have stakeholders providing ‘sweat equity’ and you are seeking to clearly define the terms and conditions by which they enjoy a stake in the company as a result of their efforts
When you have passive or silent investors putting equity into your business and you are seeking to define and/or limit the terms and conditions of their ownership of your business
When you have foreign investors entering your business and you are seeking to limit the degree of their ownership of your business so as not to trigger unfavorable corporate and tax consequences to your business and other shareholders
Advantages of Having a Shareholders’ Agreement
There is no obligation by law to enter a shareholder’s agreement. However, various benefits arise from doing so:
Fair dealings concerning every shareholder’s investment by granting safeguards of rights and protections applicable to each shareholder
Attaching different rights to different classes of shares or to varying proportional ownership of the business i.e. granting minority and majority shareholders different sets of rights
Protection of minority shareholder interests
On the other hand, not having minority shareholder interests hold up a deal to sell the company by dragging them into the sale by the majority shareholders
Disadvantages of Having a Shareholders’ Agreement
If unanimity is required for key decisions, or veto is granted to certain shareholders, then minority shareholder interests or those certain shareholder interests with veto power can hold up a deal and prevent activities of the company from taking place. Particularly where a USA is concerned: having a large number of shareholders renders it difficult to obtain consent from all shareholders of the company Note also that determining whether to incorporate your business provincially or federally poses several pros and cons depending on the intended operational structure of your business. Stay tuned for further articles from Froese Law weighing in on such considerations.
A number of common provisions of shareholders’ agreements pertain to: share issuance; share price and valuation thereof; share transfers and what is permitted or restricted; special approvals and voting thresholds; pre-emptive rights; right of first refusal; call or put options; buy or sell provisions; drag-along and tag-along rights; dispute resolution; and non-solicit and non-compete provisions. It is generally good practice to engage counsel to assist you throughout the process of drafting and negotiating shareholder’s agreements, particularly when considering such common provisions.
Froese Law can assist with shareholders agreements and further discuss these provisions with you and the reasons why they are important to have. Contact us for a free consultation!