Deciding to go into business with a partner or multiple partners doesn’t require formal documentation; it simply requires a business idea and a handshake. Many individuals will incorporate their business to shield themselves from personal liability, and then leave it at that. The problem is, everything is good until it’s not. Business arrangements are different than friendships; they are fraught with opportunities for disagreements, misunderstandings and/or unexpected events all of which could leave the business in a complicated legal situation or even at a standstill.

For example, consider a situation in which one of two individual shareholders unexpectedly dies. In this case, the deceased shareholder’s shares could transfer to his or her estate, which could result in a multitude of situations ranging from a new shareholder (perhaps the trustee) making business decisions (as the trustee now has 50% of the voting power which attach to the shares), to complex litigation. Death, disagreement, disability and divorce can all lead to costs and litigation, and that’s just the D’s. The reality is that even a small disturbance will prevent you from effectively running your business, yet alone these material disarrangements.

The solution to avoiding such complications or other disputes amongst shareholders is to retain a lawyer to draft a shareholders’ agreement. A good shareholders’ agreement will not only map out shareholder intentions on how the business should be run, but it will also set out how common and contentious issues are to be resolved in a fair (and inexpensive) manner.

Shareholders’ agreement acts as a roadmap

A customized shareholders’ agreement builds a foundation for how the business is to be managed and provides a roadmap for the business to follow. A shareholders’ agreement can be as restrictive or as flexible as you want. It may include or set out the following:

  • How the business should be managed.
  • How funds of the corporation should be distributed.
  • Whether shareholders should be required to advance working capital to the corporation, and how these funds should be treated.
  • Whether certain matters (decisions of the corporation) require the consent of a greater number of votes than would be required under the applicable legislation.
  • How shares can be transferred (or when the transfer of shares will be restricted).
  • A right of first refusal or a provision that restricts the ability for a shareholder to sell shares to a third-party without first offering current shareholders the right to purchase such shares on a pro-rata basis to prevent current shareholders from having their equity interest diluted.
  • A shotgun or a mechanism that allows shareholders to separate by forcing the party receiving the “shotgun offer” to sell their shares or buy-out the shares of the offering party.
  • A tag-along or a provision that permits a minority shareholder to participate in a sale of shares by a majority shareholder to a third party.
  • A drag-along or a provision that permits a majority shareholder to require a minority shareholder to participate in a sale of shares to a third party.
  • Forced transfer provisions or provisions that prevent shares from becoming encumbered or being transferred to unsuspecting shareholders (i.e. on death or divorce).
  • Confidentiality, non-compete and non-solicit

Thinking about drafting a shareholders’ agreement forces all parties to discuss any and all issues that could arise long before any of those issues do arise. Once an agreement is signed, all shareholders can carry on with the comfort of knowing that a plan is in place to deal with the unexpected.