A good shareholders agreement is one you hope you never have to use.
Any corporation with more than one shareholder should have one in place, but not many actually do. The corporate law firm should prepare the final document, but there are 4 major issues the shareholders can iron out themselves before they start paying lawyers fees.
Disability – If one of the shareholders becomes disabled there is typically a short-term period where the ‘all for one and one for all’ attitude prevails and the remaining shareholders pick up the slack for a period of time. If the disability turns out to be a long-term and permanent reality, the agreement functions to trigger a buyout of the disabled shareholder. The issues to consider include:
– How do we define short and long-term disability? It can be accumulated days away from work, a defined period like 6 months or determined at the discretion of a medical professional.
– What terms apply to the triggered buyout? How do we calculate the value and is there an option to make payments over time?
Divorce – This part of the agreement typically says a shareholder is restricted from giving any ownership of the shares to a divorcing spouse. It would not be fun if your business partner decided to make you a partner with his ex-wife – would it?
Death – This event is inevitable but preferably happens long after you have retired from the business! In case it happens too soon, the agreement defines how value will be determined and what terms can apply to finance the purchase from the deceased shareholders’ estate.
A ‘first to die’ life insurance policy can be included to fund the buyout of the shares in certain circumstances. The general concept is the number of shareholders is reduced by the death of a shareholder to be the remaining shareholders. The agreement would therefore not allow the distribution of the deceased shareholders’ shares among her 6 children for example.
Disagreement or Dispute Resolution – There should be a mechanism in place to resolve major disputes. It could determine an outside arbitrator or define an agreed upon dispute resolution methods. If the dispute is non-fixable, there should a mechanism for ending the agreement.
One of the best is a ‘shotgun’ agreement. If one shareholder wants to end the partnership, they can define a price and then offer to purchase the remaining shares at that price. The other shareholder or shareholders have the option to either buy or sell at that price. You can see how it forces a fair value because if the disgruntled shareholder picks a price that is too low, the other shareholder can buy them out instead of selling. If the deal can be done without going to court, the shotgun clause has worked properly.
A Word of Caution
If you are currently already part of a multi-shareholder corporation, the only time to tackle a shareholders agreement is when everyone is healthy and getting along just fine. Otherwise, the process of addressing the major issues can actually cause the disagreements that may make things worse!
Having a trusted advisor assist in facilitating the preparation of the agreement is also recommended. The presence of the outside advisor has the main function of keeping the discussions business-like and focused.
