Why Have a Shareholders’ Agreement?

By Andrew Brunton
Categories: Blog, Business Law

So you’ve incorporated a company in which you and your fellow founders own shares. Business is booming and things are going great, but they may not stay that way forever.

A Shareholders’ Agreement is a contract between the shareholders of a company and the company itself. The agreement is designed to clarify the legal obligations each party has to one another in a wide variety of situations. For companies with only a few shareholders, for example a family owned and operated business, a Shareholders’ Agreement can avoid the tragedies which can emerge from misunderstood business arrangements, unfulfilled expectations, and imbalances of power.

Many matters can be addressed in a Shareholders’ Agreement. A few of the more common provisions include those related to the management of the company, restrictions on the transfer of shares, protections for minority shareholders, and how shares are to be treated upon the death of a shareholder.

Ultimately, a Shareholders’ Agreement is a method of managing risk and establishing mechanisms to resolve problems before they arise. Let’s use an example. Alice, Brandon and Caroline decide to incorporate a company, ABC Inc. At the time of incorporation however, Caroline had less money to contribute to ABC Inc. and as such she only received 20% of the total available shares in the company. Alice and Brandon, with their deep pockets, contributed more money to the company and each received 40% of the total available shares.

A few problems can emerge from a situation such as this. For example, let’s say Brandon wants to transfer his shares to a third party. Alice and Caroline may want to restrict Brandon from transferring his shares to certain unknown or undesirable third parties. After all, they incorporated this company in order to work together with Brandon, not with some stranger! In order to lay out how the shares of a closely held company such as ABC Inc. can remain liquid, while at the same time accounting for the interests of the non-selling shareholders and applicable securities laws, specific steps and requirements for the transfer of shares from one party to another can be clearly laid out in a Shareholders’ Agreement. By establishing the procedure for share transfers ahead of time, Alice, Brandon and Caroline will all be aware of the rules of the game when the day comes that one of them wants to leave ABC Inc.

As stated, another common use for a Shareholders’ Agreement is to entrench some protections for those who are in a minority shareholding position. Minority shareholders face business risks common to all shareholders of the company; however, they are particularly vulnerable to their interests receiving a low priority in comparison to the interests of majority holders. For Caroline in ABC Inc., one form of protection she could receive for her investment are known as “piggyback rights.” Piggyback rights, if invoked, would require a purchaser of Alice or Brandon’s shares to also purchase Caroline’s shares on the same terms. Through this, Caroline can ensure that she will not be left behind should Alice and Brandon find a buyer who is interested in becoming a majority shareholder but who is not interested in spending money to acquire the last 20% of ABC Inc. More generally, provisions in a Shareholders’ Agreement governing the conduct of the affairs of the company can be used to ensure minority shareholders get a relevant say in management.

When it comes to the terms of a Shareholders’ Agreement, the parties involved can get quite creative. It is in a situation such as this that obtaining legal counsel is more necessary than ever.

This article was written by Brian Stephenson, an articling student currently working in our Business Law Group.

Andrew Brunton is a business lawyer at Pushor Mitchell LLP. You can reach Andrew at 250-869-1135 or brunton@pushormitchell.com. Our office offers a wide range of legal services to all types of corporations. For more information on our Business Law Team, please visit www.pushormitchell.com/service/business-law.