A Shareholder Agreement is first and foremost a contract between the owners of a company. The shareholders enter into an agreement to determine rules and processes for managing the company and its ownership structure. Important provisions within a Shareholder Agreement include the decision-making powers of directors and shareholders, restrictions on the sale and transfer of shares, and the process for resolving disputes.
Shareholders and directors can make decisions by holding a meeting or by signing a written resolution.
For a shareholder meeting or a director meeting to take place, a quorum of shareholders/directors must be in attendance. For a shareholder meeting, the Shareholder Agreement will define quorum as either (1) a majority of voting shareholders, or (2) all voting shareholders. For a director meeting, quorum will be defined in the Shareholder Agreement as either (1) a majority of directors, or (2) all directors.
Where a meeting is required, shareholders and directors do not need to be physically in the same location. They may participate in a meeting through a phone call, a video conference, or any other electronic means.
A shareholder meeting must be held, or a shareholder resolution must be prepared, at least once a year to approve the company's financial statements and annual corporate return.
Powers of Shareholders and Directors
By default, the laws governing corporations in Canada give extensive powers to a company's directors. In some companies, this legal default situation is satisfactory and the directors can make all important decisions for the company. In other companies, particularly small and growing companies, the shareholders want to directly make important decisions without relying upon the directors. A Shareholder Agreement transfers those powers away from the directors to the shareholders.
Founded allows for a Shareholder Agreement to be generated which transfers these powers to the shareholders for the following important decisions:
• Changing company bylaws
• Changing officers
• Merging or winding-up the company
• Disposing of the company's assets
• Changing the nature of the company's business
• Acquiring shares in another company
• Entering into a partnership
• Redeeming or purchasing the company's own shares
• Declaring dividends
• Lending or borrowing money
• Changing signing authority on company bank accounts
• Appointing an auditor
• Changing the company's fiscal year
• Making payments to directors, officers or shareholders
It is helpful to clarify that shareholders are not automatically entitled to be employees of the company. This way, a shareholder's employment responsibilities are separate and apart from their responsibilities as a shareholder. In some companies, shareholders will always expect to receive compensation as a salaried employee, so a guarantee of employment could be in their best interest.
Company Information Rights
Shareholders are always entitled to review some of the company's basic information, such as its articles of incorporation or its minute book. Some shareholders insist on having greater access to the company's records than simply its legal documents. For example, shareholders often request access to the corporation's banking and financial records. Once documented in the Shareholder Agreement, the shareholders will all have access to these additional records, so long as they do not cause undue disruption to the company's business.
Board of Directors
Directors are appointed by the shareholders to oversee the company's management. Within the Shareholder Agreement, the shareholders can determine how directors will be appointed to the Board of Directors. There are two common ways of appointing directors: (1) Each director is elected by a majority vote of shareholders, or (2) Each voting shareholder will appoint one director to the board. One person can act as both a shareholder and a director, so it is quite common for shareholders to simply appoint themselves (or their representatives) as directors.
Competition, Solicitation and Confidentiality
Competition, solicitation and confidentiality relate to shareholders' conduct both while holding shares in the company and in the future after they sell or transfer their shares to someone else.
Companies generally want to prevent any shareholder from becoming involved with one of their direct competitors. This way, a shareholder cannot use its knowledge of the company's information and strategy to assist a competitor. At the same time, shareholders are entitled to conduct business and pursue new opportunities. So a non-competition provision can ensure a shareholder does not become a competitor, but this restriction must be limited and reasonable in the circumstances.
A non-solicitation provision prevents a shareholder from trying to solicit the company's clients for another company. It also prevents a shareholder from encouraging the company's employees to work for a competitor. Similar to a non-competition provision, a solicitation provision can only be enforced for a limited amount of time and within a limited geographical distance.
Shareholders will usually have access to a company's confidential information, which can include everything from trade secrets, financial projections, or business plans. Once a shareholder sells their shares and ceases to have a relationship with the company, it's important that this information remains protected. By including a confidentiality provision, the shareholder is promising to keep that information confidential and may face serious legal consequences for improper disclosure.
Shareholder Death or Incapacity
In the event a shareholder dies or becomes incapacitated (meaning they are mentally or physically unable to perform their duties as a shareholder for a period of 12 months), the company will need to continue operating without that shareholder and make decisions about the ownership of their shares.
A common solution is to allow the company or its existing shareholders to purchase the shares of the deceased shareholder. Otherwise, arrangements will have to be made with the deceased shareholder's estate representatives, just like other property owned by that individual.
If a shareholder refuses to follow the procedures and rules set out in the Shareholder Agreement, they are in "default" under the agreement. Many companies impose sanctions on shareholders who fail to respect what is contained in the Shareholder Agreement. A common sanction is to give the other shareholders the ability to purchase the defaulting shareholder's shares at a discounted price. This helps in two ways: (1) It discourages shareholders from defaulting under the agreement, and (2) It provides an easy way to remove the defaulting shareholder from the company.
A key component of a Shareholder Agreement is to determine how disputes will be resolved when they arise between shareholders in the future. There is no right answer for all situations, but the shareholders should give some thought to how disputes will be most effectively resolved.
Mediation is one way disputes may be resolved quickly and inexpensively, but it requires the goodwill and participation of all shareholders. Mediation is an informal process where the shareholders will meet and try to resolve the dispute among themselves. A professional mediator could be hired by the shareholders at their discretion to help with this process. If mediation fails, the parties will seek a resolution through the courts or through private arbitration.
Arbitration is just like a court, but the parties will hire an independent arbitrator to resolve the dispute rather than a judge. The process is more flexible and can be tailored to the needs of the parties. Because the parties control the process, arbitration can be cheaper and quicker than going to court. Also, arbitration takes place in private, instead of a public courtroom, so the details of the dispute will not be known to the public. This can prevent a dispute from leading to negative PR.
Issuing shares is the process of creating new shares in the company and distributing them to shareholders. When issuing shares, you will be increasing the total number of shares in the company.
In order to avoid diluting the percentage of the company owned by existing shareholders, the Shareholder Agreement can give "Pre-emptive Rights" to the existing shareholders. Pre-emptive rights allow the existing shareholder to purchase newly issued shares before any new shareholder can acquire them.
A "Put Clause", also referred to as a "Buy-Back" clause, gives the shareholders the right to require the company to purchase their shares back from them at any time. This can benefit shareholders because a put clause ensures the shares are always liquid and easily convertible to cash. However, the process for determining the value of the shares does not ensure the shareholder will be pleased with the price the company is required to pay.
The Shareholder Agreement will allow the shareholders to choose between three different methods of valuing the shares when the shareholder exercises the put clause: (1) The price the shareholder originally paid for the shares when they were acquired, (2) the Fair Market Value of the shares (as determined through a process set out in the agreement), or (3) a set price.
A shotgun clause describes a process where one shareholder sets a price-per-share for the company's shares. The other shareholder(s) must then either sell their shares at that price or purchase the shares belonging to the shareholder who set the price. Generally, a shotgun clause is favourable to the shareholder who has access to capital quickly, as there is a fairly narrow time period for shareholders to decide if they will buy or sell shares.
A shotgun clause always results in at least one shareholder transferring their shares and leaving the company, so it can be an effective way to resolve disputes and deadlocks among the shareholders.
Right of First Refusal
Under a Right of First Refusal, if one shareholder has received an offer to sell their shares, all other shareholders will have the first opportunity to match that offer. A Right of First Refusal ensures that the existing shareholders get to decide whether a new shareholder is allowed to purchase shares, or whether the existing shareholders want to simply purchase the shares. It may also add cost and complexity to a purchase offer. A Right of First Refusal is often compared to a Right of First Offer.
Right of First Offer
Under a Right of First Offer, a shareholder who wishes to sell their shares must first offer those shares to the existing shareholders at a specific price. If no existing shareholder chooses to purchase those shares, the shareholder is free to sell to anyone so long as the price of the shares is equal or higher than what was offered. A Right of First Offer is often compared to a Right of First Refusal.
A Drag Along clause requires minority shareholders to sell their shares once the majority has agreed to a takeover of the company. This increases the majority's ability to negotiate a sale of the company, as the purchaser will not be required to negotiate with people who only own a minority stake in the company. Instead, the minority shareholders are "dragged along" in the transaction once the majority has agreed to it.