What is a shareholders’ agreement and what are the most important issues to address in your shareholders’ agreement? The shareholders’ agreement is a written contract between the parties who are starting or investing in a business. Its purpose is to clarify what the parties originally intended and clearly establish the roles and rights of each party. That way, as time passes, the business develops and becomes more complex (read: more profitable), the original goals and terms of the shareholder agreement may remain intact.
If a shareholder dispute arises down the road, the shareholders agreement serves as one of the best ways to not only prevent them from arising but to resolve these disputes. Because it’s in writing, these agreements force the shareholders to address hypothetical (or ‘what if’) scenarios to determine what action will be taken in the event that one of these scenarios arises. It allows decisions to be made when heads are clear and emotions aren’t involved.
Some of the Most Important Issues to Address in a Shareholders’ Agreement
These are a few of the most important issues to address in a shareholders’ agreement. Your business model or industry will no doubt present issues specific to that model or field that should be addressed, but there are a number that are universal. Here are the 3 most important things to include in your shareholder agreement:
- Management of your business
Who can be a shareholder? Who can serve on the board of directors? What is the distribution of responsibility? Will one shareholder be responsible for doing a specific measure of the work? If so, it might be worth creating an Employment Agreement to ensure that ‘working’ shareholder is adequately compensated from income before dividends are split up.
- Preferences
Are there going to be different “classes” of shareholders? Will specific shareholders (“preferred shareholders”) be given priority in the event of liquidation? Will minority shareholders sell their shares with majority shareholders in the event of sale or will the majority be able to force the minority to sell? [Ask about “drag along/tag along”] What happens in a merger?
- Buying out one partner’s shares
In the event of situations such as death, divorce, bankruptcy or disagreement, it would be wise to determine ahead of time what happens to a partner’s shares. What would represent a fair, current price (valuation) for the shares? Who is to have first right of refusal in a buyout?
- Resolving disputes
How will shareholder rights and disputes be handled in the event that shareholders with equal ownership rights disagree on a course of action? Defining a neutral third-party (such as an attorney or other officer) to serve as a board member with a small, but tie-breaking percentage of voting power might be a solution. Where will disputes be resolved (Mediation? Arbitration?)
When clearly defined in advance, these are some of the most important things to address in a shareholders’ agreement that will help to avoid lingering disputes over issues that can cripple a company. It is also important to be able to rely upon a trusted general counsel to advise you on how to best answer these and other questions when drafting a shareholders’ agreement or in the event of any dispute. The Watkins Firm brings more than 40 years of experience in business and shareholders’ interests here in San Diego and Southern California. We invite you to review our recent Podcast Episode 14 – Shareholders’ Rights and Disputes as well as the strong recommendations of our clients and contact the Watkins Firm or call 858-535-1511 for a complimentary consultation today.
