Shareholder and Partnership Agreements

Starting a new business with new business venturers can be an exhilarating time. There are so many practical matters to deal with: securing a location, arranging financing, obtaining licenses, checking markets, and a myriad of other details that demand all of your attention.

One matter that often gets overlooked in the initial flurry of activity is the proper documentation of the business arrangement between the business venturers.

Whether you are entering into business as an incorporated company (in which all of the venturers are shareholders) or by way of a partnership (where the venturers are partners with each other), it is of the utmost importance that the understanding of the venturers with respect to the present and future operation of the business be put in writing while the parties are on good terms.

Incorporated Companies

Many people dont realize that neither the incorporation documents of a company nor the Company Act provide for what happens if one shareholder decides he wants to leave the company. In addition, there is no provision for the resolution of disputes between shareholders, except in the extreme situation of having to close down the company, or to launch a minority shareholders lawsuit.

We have often been asked by shareholders some time after incorporation: "We want to get Joe out of the company. How do we go about doing it?" If our response of "Is there a Shareholders' Agreement?" is met with a "No, we didn't get around to it", we have to explain that they will need to work something out by agreement with Joe because there is no tool at their disposal to force Joe either to sell his shares or for him to buy out the other shareholders. (Unless Joe ownes less than 10% of the shares.)

In addition, unless there is an agreement that restricts the sale of shares to a third party without first offering them to the remaining shareholders, you could be faced with the situation of having a stranger involved in your company without your consent. Practically speaking however, this will only constitute a problem if the party wishing to sell shares controls the board of directors of the company as the directors must authorize the transfer of any shares in a privately held, non-reporting company.

Setting out how departing shareholders will be dealt with is only one function of a Shareholders' Agreement. The Agreement may also cover the following matters:

• Can the minority shareholders have a right to a seat on the Board of Directors.
• How will the company be financed? If the company needs money, can it call upon its shareholders to contribute money in proportion to their shareholdings? If only some of the shareholders agree to contribute, what remedies are available against the shareholders who don't?
• How will profits be divided among the shareholders? Will the distribution of profits be left flexible to be decided by the directors each year, or will the shareholders agree in advance upon a certain level of reserves to be maintained by the company to deal with contingencies?
• What function will each shareholder perform in the company? Any job descriptions, titles or salary requirements may be included in the Agreement or may be settled by way of a separate employment agreement.
• What sorts of decisions will require the unanimous approval of all shareholders? Matters such as borrowing money above a certain amount, capital expenditures above a certain amount, the company entering into a contract with one of the shareholders, the sale of the business or the amalgamation of the company with another company are just some of the matters for which you may wish to have the unanimous consent of the shareholders.
• What happens upon the death of a shareholder? Will the company carry life insurance on the shareholder? If so who will own the life insurance policy? If insurance is not available or not sufficient to pay out the deceased shareholder's interest in the company, over what period of time will the estate of the deceased shareholder be paid, and with what amount of interest?
• Will the shareholders have a right of first refusal on each others shares if one of them wishes to sell?
• Will there be a "shotgun clause"? This means that upon notice given by a shareholder, then either the other shareholders have to buy the notice giver's share at the price stated, or the notice giver will be entitled to buy the others' shares at the same price. (One must be cautious with this clause if the shareholders are of differing financial strength.
• What happens if a shareholder defaults under the terms of the Agreement? Can the other shareholders buy him out at an appraised value, less a certain percentage, as a deterrent
• Will there be any mechanism for the resolution of a dispute between the shareholders, such as mediation or arbitration?

Partnerships

Venturers involved in a partnership have very similar issues with the additional concern that each partner is liable for the entire indebtedness of the partnership. Therefore, even tighter control should be kept on the activities of the partnership and securities or indemnities may be necessary in certain circumstances.

Put it in Writing

It is very important that people entering into a business venture consider all of the above matters prior to committing their money. A full and frank discussion of these issues and a commitment in writing will be of great assistance should a dispute arise in the future or should one person simply wish to move on. As long as the people involved in the business venture are still on speaking terms, it is not too late to document the arrangement between them.

Cost is Relative

The expense of a shareholders agreement, partnership agreement, or joint venture agreement is is almost always a fraction of the cost of litigation or business losses arising from a nasty dispute amongst venturers who don't have such an agreement. 

This article is not legal advice and a lawyer should be consulted on any specific case.