How a Shareholder Agreement Protects Your Interests

03 Oct How a Shareholder Agreement Protects Your Interests

Forming a corporation is a complex process with many facets. One important component that is often overlooked is the creation of a shareholder agreement.

While it is certainly possible—and still a good idea—to create a shareholder agreement later, stakeholders in the company protect their interests best when they work with an experienced lawyer to develop a shareholder agreement at the outset. To understand why it is helpful to review the functions of shareholder agreements.

Understanding Shareholder Agreements

At its most basic, a shareholder agreement is exactly what it sounds like—an agreement between shareholders in a corporation. These agreements set out the governance and operational responsibilities of the parties related to the business of the company.

Under corporate governance statutes, certain responsibilities rest by default with the directors and officers of the company. A shareholder agreement can take those responsibilities out of the hands of the directors and give them back to the shareholders. This can represent a monumental power shift if done correctly.

Shareholder agreements can be unanimous between all company shareholders, or they can be created between certain shareholders while others remain outside the agreement. These two types of agreements are governed differently under the (Ontario) Business Corporations Act (OBCA) and the Canada Business Corporations Act (CBCA.)

Putting Decisions in the Hands of Shareholders

A shareholder agreement can set different thresholds for decision-making. For instance, the agreement might specify that if the corporation undertakes certain actions such as issuing shares or amending the Articles of Incorporation, or venturing into a new line of business, the decision requires approval from 70% of shareholders. Or the agreement could require the approval of one specific shareholder.

With a shareholder agreement, you can adjust the voting thresholds for various issues and decide whether they should be handled at the board level or shareholder level.

Shareholder agreements often set the ground rules for the issuance of new share capital. Whether the corporation issues shares to existing shareholders or new shareholders, the agreement can establish rules, such as requiring that shares be offered to existing shareholders before they can be issued to a third party.

Managing Dispute Resolution

Shareholder agreements can prevent many potential conflicts because they make expectations and obligations clear. When conflicts do arise, these agreements can minimize the potential for expense and disruption by establishing procedures for dispute resolution.

For example, an agreement might explain that if the board is deadlocked on a decision, the matter will be taken to the shareholders with votes determined on the basis of holdings. Or the agreement could specify that a professional accountant (for example) breaks ties, or that disputes that cannot be resolved will be settled through mediation or arbitration rather than litigation.

Get the Protection of a Shareholder Agreement Right from the Start

Conflict can kill a business. That is one critical reason it is a good idea to develop the terms of a shareholder agreement as early as possible. It is also much easier and more cost-effective to negotiate terms among a smaller group of shareholders at the start of the corporation rather than later on when many others may be involved.

Sophisticated investors will expect to see a thoughtful shareholder agreement in place. Since any venture that wants to attract quality investors will need a shareholder agreement at some point, it makes sense to put that agreement in place at a time when it is easiest and provides the greatest level of protection.

Abrahams Works With You

As lawyers for entrepreneurs, Abrahams LLP works with start-ups to lay the groundwork with straightforward shareholder agreements as well as more complex agreements for larger corporations with intricate financial investments. We tailor agreements to your specific needs and can help amend agreements as those needs change.