What is a Shareholders' Agreement?

What does a shareholders' agreement look like?

It's a legally-binding document drafted and signed by all shareholders. The length of the document depends on its degree of complexity, the structure of the business and your industry. 

Like a will or a marriage contract, drafting a shareholders' agreement requires a high level of knowledge and expertise. It must be tailored to your specific situation. That's why, in most cases, it doesn't make sense to try to save a few dollars by drawing it up yourself. Ask for expert assistance from a legal professional who specializes in business. 

What's the purpose of a shareholder's agreement?

An ounce of prevention is worth a pound of cure. A shareholders' agreement can help make sure your business is prepared for whatever the future may bring. By setting rules from the start, you can prevent or resolve issues and conflicts among shareholders. You'll also protect your business from unexpected events, such as the departure of a majority shareholder. A shareholder's agreement can:

• Prevent conflicts by establishing mechanisms and rules.
• Establish a method to calculate the value of the business. 
• Define the structure of the business in the event of a reorganization, a departure, the death of a shareholder, etc.
• Protect and reassure shareholders, employees and investors.

For example, to protect minority shareholders, the agreement could include a piggyback clause. In the event of a buyout of a majority shareholder’s shares, this clause allows minority shareholders to sell their shares at the same time, meaning they are not forced to do business with an unwanted new co-owner.

What should be included in a shareholders' agreement?

You can decide what rules and topics you want the agreement to address. Here are a few of the most common clauses: 

• Voluntary exit provisions for shareholders who want to sell their shares (price, terms and conditions, timeframes).
• Forced exit provisions if a shareholder can no longer fulfill their duties (or, in the event of inappropriate behaviour or fraud, to prevent them from tarnishing the image of the business).
• Provisions for buyout of shares or of the business (including an employee buyout option) 
• A shotgun clause to end unresolvable conflicts between shareholders. Can allow a shareholder to force another shareholder to sell or buy their shares so that they can exit the business.
• Provisions in the event of the death, disability or incapacity of a shareholder. For example, requiring an assessment of the fair market value of shares at a certain date. 
• Provisions for distribution of dividends.
• Provisions for a share valuation method.
• A veto power clause. 
• Non-competition, confidentiality and non-solicitation clauses.
• Provisions for distributing responsibilities among shareholders.
• Terms and conditions governing financial contributions, guarantees and the release of guarantees. These can specify terms for loans made by shareholders to the business and vice-versa, as well as the responsibilities of endorsers and conditions governing the withdrawal of an endorsement, if applicable
• Information on each shareholder's life insurance plan. 

Shareholders can take out a life insurance policy that allows their shares to be automatically redeemed at death for a pre-established amount or according to a predetermined share valuation method. The other shareholders are named as beneficiaries on the life insurance policy. Otherwise, they may end up having to run the business with the heirs of the deceased shareholder. Pro tip: Review this clause every 5 years or whenever significant changes occur.

When should you sign a shareholders' agreement?

The earlier the better, for several reasons:

• Setting clear rules from the start helps prevent conflict and tension. Imagine if the refs changed the rules partway through a hockey game. Neither the players nor the fans would be happy! The same goes for business.   
• It's often much easier to come to an agreement before the business gains value. As soon as money gets involved, emotions can start running high. It's like a cohabitation agreement: It's better to agree on the rules when everything is going smoothly, rather than after a conflict breaks out.
• A shareholders' agreement also helps attract financing from investors. They will ask for a copy of the agreement and may request that certain clauses or conditions be added before investing in your business.

Do you need to draw up a shareholders' agreement for a family business?

Absolutely! People who have gone into business with family members or friends will tell you that it can be even more difficult to resolve business issues when your personal relationships are close. This is normal. Business is a sensitive topic. A shareholders' agreement will help keep everyone happy. 

Drafting this essential document is among the best practices you should adopt when you go into business with other shareholders. Running a business can be quite the challenge. To avoid preventable issues, ask a professional to help you draft a shareholders' agreement. We're here to answer your questions.