Right Foot vs Wrong Foot

Congratulations on your new corporation! What's next?

Maybe you are a "solopreneur" and welcome the challenge of running your own show.

But maybe your business has grown and now is the time to bring on partners or investors to help take your business to the next level. And maybe the plan has always been to start a business together with some friends.

In either case, before you embark on this journey with others, you should seriously consider implementing a Shareholders' Agreement first. It may feel counter-intuitive to ask shareholders to think about their individual rights at a time when you are focusing on getting your business idea off the ground and are "all in it together".

But Steve Jobs and Steve Wozniak had a shareholders agreement when they founded Apple Computer Company in 1976 and maybe you should too. A shareholders' agreement forces founders to think about aspects of a business that they may not have considered:

1. How will decisions get made?

2. How will shareholders put money into the corporation?

3. How will shareholders be paid their return on investment?

4. How will shareholders exit?

It is also a great opportunity to consider unlikely or worst-case scenarios while the parties are all still getting along. Because shareholders agreements require shareholders to consider their individual interests as against other shareholders, they can reveal stark differences in expectations and priorities. Asking the difficult questions up front can save everyone from expensive disputes later on and help make sure the business is starting on the right foot.

How Decisions Get Made

The law gives shareholders approval rights in certain fundamental matters regarding the corporation (such as amending the articles of the corporation, amalgamating with another company or winding-up the corporation). Without a shareholders' agreement, the board of directors would manage the business and affairs of the corporation and make most of the day-to-day decisions.

But with a shareholders' agreement, shareholders can retain more direct control over the company by granting themselves approval rights over additional matters, such as issuing additional shares, making material acquisitions or changes to the business or implementing share option plans.

Shareholders' agreements can also specify who gets a say on what, who gets a seat on the board, how shares are to be voted and who has regular access to important information such as budgets and financial statements (which shareholders would not otherwise be entitled to by law).

How Money Comes In

A shareholders' agreement can set out how funds will be raised for the company's business. Should shareholders be compelled to contribute capital? Should they be required to guarantee the company's debts? Should only some or all shareholders able to participate in future share issuances (i.e., to stay "undiluted")?

How Money Goes Out

A shareholders' agreement can provide for shareholders to approve a dividend policy or approve each dividend before it is paid. In addition, profit-sharing arrangements can be baked in, as can arrangements for the repayment of shareholder loans.

How Shareholders Exit

The articles of any private company will require that all share transfers be approved by the board or as set out in a shareholder agreement. It is common for shareholders’ agreements to set out how a shareholder can sell, transfer or encumber their shares in the corporation. Typically these could take the form of "rights of first refusal", "shotgun (buy/sell)" provisions, "drag-along" and "tag-along" clauses, including mechanisms that kick in to deal with the shares of a shareholder in the event of their disability, death, bankruptcy or divorce.

Careful consideration and drafting by an experienced lawyer will help reduce headaches down the road, break deadlock among shareholders and prevent unfamiliar parties from becoming shareholders.

Other Common Provisions

Other common provisions that are often set out in a shareholders' agreement include non-competition and non-solicitation clauses, as well as confidentiality and non-disparagement clauses, to help protect the other shareholders and the corporation itself.

Shareholders' agreements also often include an "arbitration clause" which requires disputes to be resolved via arbitration (where proceedings are typically less costly and more efficient than in court). Arbitrations are also usually kept private and confidential.

Key Take-Away

An ounce of shareholders' agreement can be worth a pound of problem-solving later on. Shareholders' agreements can set your company up for success and help reduce the risk of costly and distracting litigation down the road.

You should involve a lawyer to help implement a shareholders' agreement. An experienced practitioner, through thoughtful drafting, can help find the right balance between certainty and flexibility in view of your needs and the needs of your partners and the company itself. A lawyer can also help you understand how various provisions and clauses (such as a right of first refusal) would work in case they come into play and why you may or may not need them.

Shareholders' agreements also often deal with the movement of money - so be sure to consult a tax advisor to understand any tax-specific requirements that may be relevant.

SkyLaw has years of experience helping entrepreneurs with shareholders' agreements. See how SkyLaw can help!

*Image courtesy of Sotheby's