Understanding Shareholder’s Agreements
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 unfavourable corporate and tax consequences to your business and other shareholders
While parties to a shareholder’s agreement are typically individuals, shareholders could also be holding companies themselves. In such instances, the individuals who own such holding companies should also sign the shareholders’ agreement to cause their holding companies to perform the obligations stipulated. If you are the owner of such a holding company, you would not be able to then sell the shares of said companies unless you complied with the shareholders’ agreement.
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 bylaws 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. It furthermore governs the activities of the board of directors. In fact, its key feature is that is can override the power directors of the board enjoy under common law by transferring these powers to the shareholders. Depending on the parties and the nature of their relationship, shareholders’ agreements can serve various purposes. Where two shareholders are equal partners, for instance, 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 (note, however, that quorum cannot be lower than statutory minimums in place). The bylaws of the business and the shareholders’ agreement should be also reviewed in tandem to ensure they do not conflict.
Furthermore, shareholders’ agreements are used to confer rights and obligations upon shareholders, including the following:
The manner in which shareholders can transfer their shares
Allowing shareholders access to information beyond regulated disclosure requirements
Providing existing shareholders pre-emptive rights on buying newly-issued shares
Granting particular shareholders right of first refusal on the company’s sale of shares or of assets
Non-solicit and non-compete provisions placed on shareholders to prevent their competition upon leave or a walk-off with the company’s clients
In situations where a majority of shareholders wishes to sell their shares, dragging along minority shareholders to sell their shares as well
Dealing with voting rights i.e. allowing the parties to vote their shares in a particular manner, or coming up with proxies that would result in their shares being voted in that manner
Shareholders’ agreements are subject to the articles and bylaws of the company, as well as the corporate statute in the jurisdiction they are incorporated. In Ontario, shareholders’ agreements are subject to the Business Corporations Act (Ontario)(“OBCA”) if the company is provincially-incorporated there; and are subject to the Canada Business Corporations Act (“CBCA”)* if they are federally-incorporated.
Advantages of Having a Shareholders’ Agreement Note 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. Stay tuned for further articles from Froese Law discussing these provisions and why we have them.