A shareholders agreement is an important contract entered into by the owners of the stock of a corporation. ENDEAVORLEGAL business lawyers assist the shareholders of client corporations in the consideration of a number of items that cause disputes among the shareholders down the road if not attended to at the time of corporate organization. A shareholders agreement memorializes the decisions the parties made in advance to handle significant issues as they arise. Without the benefit of a shareholders agreement, when a dispute arises in regard to the resolution of a matter facing the corporation, the shareholders often disagree about address the issue. Either the shareholders did not take the time to consider each contingency before going into business or each shareholder remembers conversations and oral pacts differently. Either way, there is often a dispute about how to proceed. A well-written contract provides great assistance in resolving issues by forcing the shareholders to address a number of “what if” scenarios long before any of them has the chance to occur. Entrepreneurs starting new businesses are generally on good, and even friendly, terms during the infancy of the enterprise. However, when things are not going so well or the life circumstances of the shareholders change, disagreements often arise. It is wise to turn your attention to these often divisive topics when they are merely abstract concepts rather than harsh realities.
With the assistance of our experienced business lawyers, you can prepare a clear and concise contract to take into account a variety of scenarios that go a long way toward minimizing misunderstandings, disputes and costly litigation. At ENDEAVORLEGAL, we guide our corporate clients through the process of preparing and executing a detailed shareholders agreement to safe-guard the interests of, and relationships between, the shareholders.
Topics to Consider Including in a Shareholders Agreement
The type of provisions to include in a shareholder’ agreement depends in large part on the particular circumstances of each business venture. Common provisions include:
Limitations on who can become a shareholder, director or officer of the corporation. Director and officer compensation is also commonly addressed.
The time commitment which each shareholder must promise to the service of the corporation in exchange for his or her ownership of shares. Ownership of shares is often subject to forfeiture for a number of years in the event the shareholder fails to live up to his or her commitment obligations. These considerations are sometimes addresses in the shareholders agreement. In other case, time commitment and risk of forfeiture is dealt with in individual stock restriction agreements.
Restrictions on activities by a shareholder that would be in competition with the business of the corporation.
Procedures to be implemented in the event a shareholder resigns, is terminated, retires, files for bankruptcy, gets divorced, becomes permanently disabled or dies.
A method of fairly calculating the value of shares of the corporation’s stock.
Institution of rights of and/or obligations to purchase the stock of a shareholder in connection with the occurrence of one or more of the events identified above. Procedures for the purchase should also be considered.
Establishment of a purchase price for the shares of a shareholder with respect to whom one or more of the events identified above has occurred. The purchase price can be different depending on which event triggers the redemption or repurchase of the shares. For instance, in the event of the death or permanent disability of a shareholder, the purchase price per share may be one hundred percent of the established value of such share. However, if the repurchase results from the shareholder’s employment with the corporation being terminated for cause, the purchase price may be some lesser percentage of the full valuation per share.
Each shareholder must voluntarily agree to become a party to the shareholders agreement. The parties cannot force someone to enter into the contract; however, the corporation can refrain from issuing shares to a party who elects not to enter into the proposed shareholder agreement.
The most common type of shareholder agreement is a buy-sell arrangement which spells out the details of the purchase and sale of shares of the corporation’s stock. Some agreements provide that the corporation will repurchase the shares of a shareholder upon the occurrence of a triggering event. In this circumstance, each shareholder will receive a pro rata share of the economic benefit associated with the redeemed shares. Other agreements provide that each shareholder will have the right to purchase a portion of the shares based on his or her percentage ownership of all outstanding shares of the corporation’s stock. Many agreements offer the existing shareholders the opportunity to purchase the shares, and, in the event not all the shares are purchased, the corporation is obligated to buy the remaining shares available for purchase. Some agreements provide that these purchases be optional while others state that a redemption by the corporation or repurchase by existing shareholders, or some combination of the two, is mandatory.
Right of First Refusal
A right of first refusal provision requires a shareholder desiring to sell or transfer his or her shares to a third party to provide the details of the proposed sale to the corporation and permit the corporation and remaining shareholders to match the offer received from the outside party and purchase the shares. A right of first refusal prohibits a departing shareholder from selling his shares to anyone without the remaining shareholders knowledge or consent. When a shareholder possesses and unrestricted right to sell or transfer his or her shares, the other shareholders are placed in a position where they could effectively be forced into business with someone who might not possess the same skill set as the selling shareholder or have personality traits that conflict with those of the remaining shareholders.
Right of Co-Sale
A right of co-sale provision prevents a situation where majority shareholders “jump ship” and sell their shares to a third party. The co-sale right provides the other, usually minority, shareholders the right to sell a portion of his or her shares on the same terms as the shareholders proposing to sell their shares to a third party. This right is typically on a pro-rata basis of its total ownership percentage in relation to the total sale.
Valuation is generally determined in one of two ways: The first is to provide a stated dollar amount per share that is agreed to by all parties and can be adjusted on an annual basis; the second is the institution of a formula that will be used to determine a fair price at the time of a triggering event. It is often wise to engage the services of an accountant in putting such a mechanism in place.
Funding the Repurchase
Unless the corporation has purchased an insurance policy to provide funds to be used in the purchase of a selling shareholder’s shares, the remaining shareholders may find themselves using personal funds to pay for their repurchase obligations. Often, shareholder agreements will require the shareholders to purchase life insurance policies on one another. It must be noted that proceeds from a life insurance policy can only fund a purchase of shares upon the death of a shareholder. For this reason, a shareholder agreement generally provides that the payment of the purchase price for shares upon death will be made in a lump sum upon receipt of insurance proceeds. Other triggering events permit a schedule of payments over a longer period of time to avoid financial hardship among the remaining shareholders.