24 Oct What Provisions Need to Be in Your Shareholder Agreement?
Shareholder agreements protect some of stakeholders’ most basic rights–but only when those agreements are properly drafted. Whether shareholders are working together as a group to negotiate an agreement or one shareholder has taken the initiative to draft an agreement, it is a good idea to include certain essential provisions.
Your business lawyer should review the specific needs of your situation and develop a plan that protects your interests. Here are some provisions to keep in mind as a general rule.
Future Financing Expectations
One of the most important sets of provisions to include in a shareholder agreement deals with how future financing will be handled. If the corporation needs money, is it going to:
- Look to a financial institution for debt financing?
- Put out a capital call to shareholders?
- Expect one shareholder to act as financier?
- Go to third parties for equity investment?
The agreement should address the shareholders’ expectations, which could differ according to the type of need.
Distributions to Shareholders
A shareholder agreement should also address the issue of distributions. What specifically needs to happen for the company to be in a position to issue dividends? When will the assessment be made? What are the legal restrictions to navigate before doing so? Will the board of directors make the decision or will shareholders vote on the issue?
The shareholder agreement should specify which types of decisions need to be voted on by shareholders rather than simply managed by the directors or the officers. Corporate laws of Ontario and Canada generally give decision making authority to the board of directors by default, so shareholders need to be clear about what authority they want to take back for themselves.
In addition, the agreement should set ground rules about what constitutes a quorum at any meeting for directors as well as shareholders. Also, the parties should consider what length of notice needs to be provided to give shareholders the opportunity to vote on an issue.
Issue and Transfer of Shares
Another critical set of issues that should be covered in a shareholder agreement concerns the transfer of ownership of shares. If one shareholder wants to sell, should the other shareholders have a right of first refusal? The same question should be asked if the corporation is issuing new shares. Should existing shareholders have the right to buy shares to maintain their existing percentage of ownership?
These transfer provisions should include what are often referred to as “drag along” and “tag along” (also known as “piggyback”) clauses. In a drag along provision, when a majority of shareholders want to sell, they can force the minority shareholders to sell their shares as well so that the new owner gains 100% control of the company. It can make a sale very unattractive to potential buyers when the company has minority shareholders left behind as a group of, potentially dissenting, squeaky wheels.
While a drag along clause essentially protects the majority and the company value as a whole, a tag along clause protects minority shareholders. This type of provision allows minority holders to sell when the majority shareholders exit. In a private company, there are few opportunities to liquidate or exit, so being included in an exit with the majority shareholders can be very helpful. It also empowers minority investors by allowing them to ensure they don’t end up being a minority in a company controlled by somebody they don’t know or trust.
Abrahams Negotiates Shareholder Agreements to Protect Your Interests
A well-crafted shareholder agreement protects the interests of shareholders and the corporation as a whole. The provisions can help everyone understand their obligations and expectations, and provide for means of dispute resolution.
While it is best to initiate the process of creating a shareholder agreement at the time you form the corporation, it is never too late to get the appropriate provisions in place to govern future growth. Abrahams LLP tailors agreements to meet the specific needs of a corporation, whether simple or complex. To learn more about how we can assist with creating or amending a shareholder agreement, contact us now.