The Importance of Shareholder Agreements

What is a shareholder agreement?

A shareholder agreement is legally binding contract between the shareholders of a company that establishes their rights and responsibilities. They outline things such as voting rights, the right to receive dividends and the right to participate in major business decisions. They can also include provisions for things like buy-sell agreements, distribution of profits, the transfer of shares and business valuation. It is an important document for any company as it can help to prevent disputes and ensure that the company is run in the best interest of all shareholders.

Why are they important?

“Shareholder agreements are one of the most important governance documents for your business. If the ownership structure of your business needs to change and there is no agreement in place, negotiations between parties can often lead to costly legal disputes.” says managing director, Darryl Dyson.

While not required by law, shareholder agreements can be critical for companies with more than one shareholder, and even more important for companies where shareholders are unrelated or not in the same immediate family unit. Without a clear set of procedures in place, it may become difficult for a company to action important business decisions or resolve internal disputes, leading to lengthy delays and ultimately harming the company's performance and profitability.

What should they include?

Shareholder agreements should be tailored to the specific needs of a company, taking into consideration the number of shareholders, the type of business and the goals of the shareholders. The agreement should be regularly reviewed and updated as the company grows and evolves, ensuring the needs of the company and shareholders continue to be met. Consulting with a lawyer when drafting your agreement is the best way to ensure that it’s legally enforceable and that all parties understand their rights and obligations under the agreement.

Some of the key elements that are typically covered in a shareholder agreement are:

• Shareholder rights – such as voting rights, the right to receive dividends and the right to participate in major business decisions. This can reduce the likelihood of confusion or misunderstandings between parties and also protect the interest of minority shareholders by implementing a requirement for unanimous consent for certain types of transactions.
• Shareholder meetings – the shareholder agreement should set out the minimum scheduling of directors/shareholders meetings and the level of attendance expected.
• Distribution of profit and loan accounts – this should include a policy around the timing and method used to determine amounts to be paid as dividends and dealing with loan accounts of any directors or shareholders because of drawings.
• Buy-sell provisions - This sets out the procedure for the sale of shares and can help to ensure that the ownership of the company is clear and that shares are transferred in a fair and orderly manner. Without a buy-sell agreement it may become problematic for shareholders to determine how to handle the sale or value the company. It’s important to note, without an agreement, the default rules of the state corporation laws apply, which may not be a favourable outcome for the shareholders.
• A mechanism for shareholders to exit the company – such as right of first refusal for existing shareholders in the event of a share sale, or an option that allows shareholders to sell their shares back to the company at a predetermined price or price determined by a valuation or valuation model. A mechanism for exit allows shareholders the flexibility to leave the company if their interests diverge from those of the other shareholders and avoids parties being forced to remain part of the company against their wishes.
• Death or permanent/temporary disability of shareholders/directors should be considered, along with insurance arrangements for such an outcome.
• Restraint or notice requirements – for exiting parties’, a restraint of trade set out under the agreement is important to protect the rights of a company and limit the impact or opportunity of exiting parties to compete with the business.
• Requirement for capital - Ideally agreements should provide a procedure or mechanism for capital injections, usually this is in the form of a loan account from the relevant shareholder.
• Expectations of directors or shareholders within the business and managing outside interests and obligations should be included in a shareholder agreement. This can cover a broad range of issues such as:

• Whether specific roles and responsibilities are assigned to an individual director/Shareholder to perform on behalf of the Business (e.g. acting in the capacity as the CEO, carrying out marketing activities, interviewing/employing staff).
• Productivity levels and or direct business input expected from each director/shareholder.
• Remuneration and wages for duties performed by director and shareholders.
• Other business activities or interests of directors/shareholders should be addressed in the agreement along with how to manage such arrangements in order to address any potential conflict of interest between parties.

• Alternative dispute resolution – issues may arise which cannot be decided or resolved informally so an agreement containing alternative dispute resolution (ADR) processes, such as mediation, arbitration or conciliation is important to avoid court proceedings or negative impacts to the company.

Key takeaways? Without a shareholder agreement in place, there are a number of issues that may arise which can negatively impact the company or its shareholders. That’s why it’s important to consider if implementing a shareholder agreement is right for your business. Though preparing a shareholder agreement can be costly, investing now can avoid even more costly legal disputes down the line.