Article by Joel Attis for the Times & Transcript on June 6, 2019

A shareholder agreement is a document that prescribes the guidelines that govern the relationship between a company and its shareholders’ and the relationship between the shareholders themselves.

thomas drouault 793767 unsplashRecognizing the importance of a shareholder agreement can go a long way in protecting business owners from unwanted and unnecessary conflicts as the business grows and circumstances change. Indeed, the lack of well-constructed shareholder agreements is a primary cause of inter-company shareholder lawsuits – and typically turns close friends and even family into bitter adversaries.

You see, similar to a marriage – things change over time… feelings may change, or relationship problems may materialize. Sometimes trust is the issue, and as we all know when emotions come into play it is very difficult to have an objective discussion. A marriage contract in the case of a married couple, or a shareholder agreement in the case of shareholders, provides guidelines as to the actions that can or must be taken – thereby helping to prevent emotions from creeping into the discussion, or at least into the solution.   Here we will talk about just a few of the provisions we often see in a shareholders’ agreement:

Buy-Sell Provision

A buy-sell provision is often the main reason why a shareholder agreement is prepared. Is there a catch-22 situation that is impossible to resolve between shareholders? A Forced Sale (Shotgun) Clause can be included in order to force one shareholder to sell his shares to the unhappy shareholder(s), or to buy the shares of the unhappy shareholder(s). A quick example: Let’s say you own 30 shares of a company and your partner owns the remaining 70 shares. Your partner offers you $300,000 for your 30% of the company. A “Buy-Sell” provision in the shareholder agreement would give you the right to either accept the $30,000 offer, or counter-offer at the same price per share, being $700,000. Your partner is then legally compelled to accept your offer. Thus, a Buy-Sell provision ensures that the matter comes to a swift conclusion – one way or the other.

Right of First Refusal

An association between two or more people who want to launch a business is usually built on confidence and trust. Having said that, what would happen, for example, if a shareholder then decided to sell his shares to a third party? Can he do it without consent of current shareholders?

To avoid this type of situation, it would be wise to include a Right of First Refusal Clause in the shareholder agreement, thus ensuring that the shares will be offered to the existing shareholder(s) before being sold to a third party.

Withdrawing from the Business

It is highly recommended that a Mandatory Offer Clause be included in the Shareholder Agreement. A Mandatory Offer occurs when a situation arises that requires a shareholder to withdraw from the company, even if he or she is unwilling to sell their shares.

Valuation of the Company’s Shares

The shareholder agreement must include a clause identifying the valuation method to be used in determining the value of the company’s shares in the event of a forced share sale. Here are some of the methods commonly used to determine share value:

> The agreed value: A value predetermined by the shareholders. This method has the advantage of being inexpensive and simple to apply.
 
> The book value: This method is also inexpensive to apply. It is for the most part based on the value of the company’s assets.
 
> The value as determined by a professional, such as an accredited appraiser or Certified Business Valuator (CBV).

The first two methods are the least expensive to apply. But it can be exceptionally difficult to objectively value the intangible factors, such as expertise, competitive advantage, customer list/patronage, etc. The third method is generally preferred although more costly because it provides added piece of mind to the value for all parties involved.

There are many other provisions that could, and depending upon circumstances should be written into a shareholder agreement. It is essential to consult a legal advisor to discuss the pros and cons of including some of the clauses mentioned above in a shareholder agreement – together with contemplating other provisions that should be included.  Also, the shareholder agreement should be reviewed regularly to ensure that it continues to meet the main objectives of the shareholders who enter into it. 

In summary, a shareholder agreement is an essential tool when individuals join forces to start a company. It can be viewed as the corporation’s “marriage contract” and helps to define the parties’ rights during both the good times and the bad times.