02 Jan Why Every Company Should Have a Shareholders’ Agreement

A corporation’s shareholders’ agreement is a proactive method to establish the expectations and obligations for shareholders and set the terms for corporate management and dispute resolution. Legally and financially, it is always wise to have one drafted for your company, yet there are no requirements in corporate statutes in Ontario or the rest of Canada for corporations to have one in place. As a result, many corporations have yet to establish these rules, putting their business at risk.

In this article, we explain what shareholders’ agreements consist of, the kind of benefits that an agreement can bring, and how having one in place can save your business from liabilities.

The Elements of a Shareholders’ Agreement

Although shareholders’ agreements are highly flexible, most agreements consist of the same main parts:

• The adoption of an annual business plan that places restrictions on management fees and other expenses;
• An obligation for the company to distribute profits;
• A first-of-right-refusal on newly issued shares;
• Terms for the purchase and sale of shares; and
• Terms for how new investment is taken in and how additional shares are issued.

However, the elements of a company’s shareholders’ agreement should be interpreted differently based on the type of shareholder. For majority shareholders, it is mainly about strategically managing minority shareholders and establishing comprehensive expectations regarding their rights, as well as their own obligations. To minority shareholders, a shareholders’ agreement defines one’s entitlements as an investor and provides an explanation of what to expect if other shareholders fail to abide by the agreement’s terms. When creating an agreement for your business, these are among the aspects that must be considered.

So, what exactly are the benefits of drafting and following a shareholders’ agreement?

The Benefits of a Shareholders’ Agreement

A shareholders’ agreement protects both majority and minority shareholders. For example, an agreement may provide a minority shareholder with the right to participate in a corporation’s decision-making along with the majority shareholders, such as in share sale situations or the registration of new members. At the same time, an agreement can protect the right of a majority shareholder to sell their shares or leave the company. For example, if an agreement to sell all of a corporation’s shares to a third-party was reached, the shareholders’ agreement could protect the right of the majority shareholder to transfer all shares, including those held by minority members.

The agreement can also control the transfer of shares. Depending on its design, it can put restrictions on the sale of shares by creating a right of first refusal, meaning that other shareholders can refuse the sale of one’s shares to a third-party. In some agreements, it might be stated that other shareholders have a right of first opportunity, or the right to buy the shares of a departing shareholder.

Disputes are commonplace in the corporate world and may be what most assume is the main reason for a detailed shareholders’ agreement.  The agreement can outline the procedure in the event of a dispute between shareholders, which can be damaging to a company.

All in all, the shareholder’s agreement provides a safety net to a business’ shareholders and potential investors. By having one in place, a company can establish a base of shareholders that are protected by the terms of the agreement, and potential investors will appreciate the transparency and protections offered by the company, making it a more attractive option for investment. In the event of a dispute, the terms of the agreement can defend business owners and shareholders from legal and financial risk.

Takeaway

This article illustrates what shareholders’ agreements consist of, and the benefits of having one in place. Every business stands to benefit from implementing a well-drafted agreement to ensure the protection of majority and minority shareholders.

If you are in need of a shareholders’ agreement tailored to your specific business needs, contact a corporate lawyer at Guardian Legal Consultants today. We provide legal consultation that will ensure your business thrives, so you can focus on running your company.