- A shareholders’ agreement governs the relationship between owners and how disputes are resolved.
- The exit provisions are the most important part and the most often neglected.
- A valuation mechanism agreed in advance prevents the most intractable disputes.
- Without an agreement, a deadlocked corporation may have no route out short of court.
Why it exists
Corporate legislation and the articles set out the basic framework, but they say very little about how the owners will actually work together, what happens if one wants out, or what happens if they disagree.
A shareholders’ agreement fills that gap. It is negotiated when everyone is optimistic and it is used when they are not, which is exactly why it should be done early.
Governance
How the board is composed, and who has the right to appoint directors.
Which decisions require more than a simple majority. Typically these include issuing shares, incurring significant debt, selling substantial assets, changing the business, and related-party transactions. A minority shareholder with no protected matters has very little influence.
How officers are appointed and what authority they have.
What information shareholders receive and how often, which is a frequent source of complaint in closely held companies.
Transfers and exits
This is the heart of it. The provisions that recur:
- Right of first refusal. A shareholder wishing to sell must first offer to the others, preventing an unwanted co-owner.
- Tag-along. If a majority holder sells, minority holders can require the buyer to take their shares too, on the same terms.
- Drag-along. If a defined majority accepts an offer for the whole company, they can compel the minority to sell, so one holdout cannot block a sale.
- Shotgun. One shareholder names a price; the other must either buy at that price or sell at it. It resolves deadlock decisively but favours the party with more liquidity, which is worth understanding before agreeing to it.
- Compulsory transfer on death, disability, bankruptcy, or ceasing employment.
Valuation
Almost every exit provision requires a price, and the mechanism for arriving at one is what makes the rest work.
The options are a formula, an agreed value reviewed periodically, or an independent valuation with a defined process for appointing the valuator.
A formula is predictable but can become detached from reality. An annually agreed value works if it is actually reviewed, and is useless if the review is skipped for six years. An independent valuation is the most accurate and the slowest.
What must be avoided is silence. Where the agreement provides for a buyout at “fair value” with no mechanism, the buyout becomes a negotiation between people who are already in dispute, which is where litigation begins.
Working shareholders
In small companies the shareholders are usually also the employees, and the two roles need separating.
Compensation should be dealt with as employment, not as a shareholder entitlement. What happens to the shares if a working shareholder leaves, voluntarily, or by dismissal, should be explicit, and often distinguishes a good leaver from a bad leaver on price.
Non-competition and non-solicitation obligations given as a shareholder are treated differently from those given as an employee, and are generally more enforceable. This matters given the restrictions on employee non-competes.
Deadlock
Fifty-fifty ownership without a deadlock mechanism is a structural fault waiting to be discovered.
Mechanisms include a casting vote, an independent director or chair, mandatory mediation, an escalation process, a shotgun, or a right to require a sale of the company.
Without one, a deadlocked corporation can only be resolved by agreement or by court application, most commonly an oppression remedy or a winding-up application, both slow, expensive and damaging to the business.
Common questions
Do we need one if we are family?
Family companies produce some of the most difficult disputes, precisely because expectations were assumed rather than documented.
Can it be added later?
Yes, but it requires agreement from all parties, and the moment when everyone agrees may not come again.
What is a unanimous shareholders’ agreement?
One signed by all shareholders that can restrict the directors’ powers and transfer them to shareholders, along with the associated liabilities. It is a distinct instrument with specific effects.
What if a shareholder simply refuses to co-operate?
Absent contractual machinery, the remedies are statutory, most commonly the oppression remedy, which is broad but requires litigation.
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