Complete Guide to Shareholders’ Agreements in BC
What is a Shareholder?
A shareholder is anybody who owns shares of a company. They provide financial security to a company by investing in it in exchange for ownership. Shareholders of small businesses tend to be more involved with the overall management of the business compared to shareholders of larger businesses.
What is a Shareholders’ Agreement
A Shareholders’ Agreement serves as a tool that outlines the rights, powers and obligations of a shareholder and it dictates how a company is operated. It’s a legally binding contract that outlines the activities of a company and the rights and responsibilities of shareholders in a company which is intended to protect each shareholder's rights.
These agreements are subject to the company’s Articles and relevant corporate legislation. Articles are legal documents that set out the purpose and regulations of a business which are required to establish the business as a legal entity. The British Columbia Business Corporations Act (BCBCA) is the corporate legislation for protecting the rights of shareholders in the BC province. This aims to ensure shareholders have fair treatment and involvement in the invested company.
How does a Shareholder Agreement differ from Corporate Articles?
Corporate Articles govern corporations. They outline the rules and regulations for basic corporate governance such as the maintenance of the shareholders' registry, how directors are elected and procedures for meetings. However, they don’t deal with shareholders' rights and responsibilities or provide a complete decision-making system.
Purpose of a Shareholder Agreement
A Shareholders’ Agreement provides a higher level of detail on the company’s operations and its shareholder protection. It addresses issues such as the appointment of directors, the distribution of profits and the transfer of shares.
It’s common, especially with small businesses, to have family, friends, or colleagues as shareholders and although this is often what creates a successful business, disputes between these relationships can be difficult to navigate. The details of a Shareholders’ Agreement must be agreed upon and signed by each shareholder which can help resolve disputes that arise.
Examples of the possible ‘what if’ scenarios that could arise resulting in the need for a shareholders’ agreement include the death or incapacity of a shareholder, or when a shareholder decides to leave and sell their share of the company. If one of these situations arises and there is no shareholders’ agreement in place, it can lead to conflict between parties creating potential profit loss, the loss of goodwill between the partners, or even family rifts.
A shareholder’s agreement helps to establish clear expectations. When there is little to divide in terms of profits, a shareholder agreement may not feel necessary. However, once a business starts to generate profit and the company needs a shareholder’s agreement, it can be much more difficult.
What a Shareholders’ Agreement should consist of
A Shareholders’ Agreement can vary depending on the company’s specific requirements, but there are some key points that a shareholder’s agreement should include:
Clearly outline the rights, roles, duties and responsibilities of shareholders
How much of the business each shareholder owns.
What happens in the case of death, incapacity, retirement and all other possibilities regarding exit plans.
over the terms regarding hiring, firing and the buying, selling or transferring of shares.
Restrictive covenants such as non-competes and non-solicitation agreements
Deal with the financing of a business and the rules around regulating investments.
Every shareholders’ agreement is unique to the business needs and it is advised to seek professional legal advice before creating one to ensure it covers all relevant aspects of the company and addresses all possible ‘what if’ scenarios. The final document must then be understood and signed by each shareholder involved.
Benefits of having a Shareholder’s Agreement
A shareholders' agreement is set in place to protect shareholders and be used as evidence in the event of a dispute. It provides shareholders with a clear understanding of their rights and position in the company. Providing the provisions are clear and detailed, it also gives them security and reassurance of their investments.
It’s important to have a shareholders’ agreement in place from the onset and not to delay the creation of this vital document. They commonly fall to the wayside, especially at the start of the business when there are many other important issues to address. However, sometimes the scenarios that result in the need for a shareholders’ agreement can be sudden or unpredictable which is why it’s important to have one in place from the beginning.
Potential risks
It’s important to ensure the shareholders' agreement is clear and comprehensive to avoid any disputes over voting rights, the share of sales or dividend distributions. It’s also important to ensure the shareholders' agreement complies with BC corporal laws to avoid legal penalties.
Not having a shareholders' agreement can cause many issues and disagreements between shareholders leading to potential disputes and legal issues
For example, if the death of a shareholder occurs in the absence of a shareholders’ agreement, or if it doesn’t cover the scenario of the death of a shareholder, these shares usually fall into the hands of the deceased’s estate, something that remaining shareholders might not have anticipated or planned for which can cause great complexity for the business.
Types of Shareholder’s Agreements
General Shareholder’s Agreement
General shareholder agreements have a variety of functions. Some of the common areas these agreements cover include company management and governance, selling interests, dispute management, valuation, non-compete and non-solicitations.
They are treated as commercial contracts between shareholders and are subject to corporate laws and company articles. General shareholders' agreements typically deal with a range of issues and can be difficult to negotiate as a result as many of its provisions are context-based.
The BCBCA differs from other Canadian province Acts as it doesn’t recognize Unanimous shareholder agreements (USAs) found under the CBCA that limit some or all of the director’s powers to manage a company. Section 137 of the BCBCA is similar to USAs as it does limit a director’s powers and the transfers of them. This section outlines that a company’s articles may transfer the powers of a director for the management and affairs of the company.
These may be transferred to one or more shareholders, or other persons neither shareholder nor company director. These can also be transferred to a corporate entity allowing some or all shareholders or other persons to act in the place of the director.
Minority Shareholder’s Agreement
Minority Shareholders’ rights are protected under the BCBCA Act in the absence of a Shareholders’ Agreement. A minority shareholder owns less than half a company. Alone, they don’t have enough voting power for disputes over assets or any other issues requiring shareholder votes. These agreements are usually established in small businesses where funding is from a group, family or friends and a certain percentage of ownership is given through shares in exchange for investment.
A minority shareholders' agreement should list specific issues foreseen for the business and outline how shares will be distributed. Like other shareholder agreements, the company's health and long-term financial success should be in the details and clauses of the agreement. Any additional inclusions such as the Right of First Refusal, Piggyback Rights, and Pre-emptive Rights should also be referenced.
It’s important to note how Shareholder’s Agreements in British Columbia differ from other Canadian provinces under the CBCA. As the BCBCA doesn’t recognize unanimous shareholder agreements, a director’s powers cannot be transferred or restricted in British Columbia.
Shareholder’s Rights in BC
In Canada, one can incorporate under either federal or provincial law - most corporate law statuses across Canada are based on and are similar to the federal Canada Business Corporations Act (CBCA). Shareholders in British Columbia have their rights protected under the BCBCA.
Your rights as a shareholder include:
The right to vote
The right to vote is one of the most important rights of a shareholder. Shareholders are a part of important business decisions and their right to vote ensures their share of control over a company and the board of directors
Right to vote on:
Election of directors
Approval of major transactions
Changes to the company's article of incorporation (reword)
The right to attend meetings
Shareholders also hold the right to receive notice of and attend meetings. Shareholder’s meetings are normally held annually and are usually announced by a member of the board of directors, however a shareholder outside of the board in certain circumstances can also call a meeting if they hold a certain percentage of shares. Our team is available to advise you on these situations to ensure you are protected.
The right to access certain information
Access to information is another important right shareholders have to ensure they are fully educated and informed before making a vote. The information they are entitled to include the meeting minutes, articles and by-laws of the company, copies of all shareholders' agreements, copies of the director’s, office and shareholder registers along with the shareholders' ledger.
Receive dividends
Take legal action if they believe rights were violated
Shareholder Agreement Clauses
Right of First Refusal
The Right of First Refusal means that a shareholder intending to sell their shares must offer their shares to existing shareholders before selling to a third party.
For example, when Derek decided to leave the board of a manufacturing company and sell his shares, his shares were sold to an exiting shareholder who was given the right to create an offer before it went to an external investor.
This offer must be made at the same price the external investors would be offered. This right can prevent shares from being sold to competitors and it allows remaining shareholders to avoid another shareholder joining and the chance to buy more shares.
Pre-emptive Rights
This is a shareholders' right to be offered new shares before they are offered to external investors. Pre-emptive rights are triggered by a company issuing new shares in contrast to the right of first refusal which are triggered by a shareholder intending to sell externally.
For example, Catherine held 20% ownership of a construction company that specialized in residential builds and renovations. As part of a new project, they decided to expand and begin a commercial project consisting of 3 apartment blocks. To raise the capital required for this project, the company decided to issue new shares. As an existing shareholder, Catherine exercised her pre-emptive rights and was able to buy the new shares before they were offered to external investors.
This is usually based on a pro-rata percentage which allows shareholders to maintain their current ownership and helps protect them from dilution (also known as an anti-dilution provision). This is a benefit to shareholders but can sometimes hinder a company that is seeking to attract external investors.
Piggyback Rights
Those with piggyback rights can sell their shares if the primary shareholder sells theirs. The benefit behind these rights allows the rights holder to exit a company alongside the shareholder subject to the right, at the same rate. This can be especially important for small businesses. Often a small business's success is tied almost solely to the owner/operator. If the owner is selling his business and he also operates, having the option to sell your shares alongside the primary owner can be useful.
Piggyback rights, due to their nature, often discourage shareholders from finding buyers and they often only apply to shareholders who are essential to the company’s success.
Drag-along Rights
A drag-along right enables a shareholder with the majority of the shares to force the minority shareholder to join them, dragging them along, in a sale. This makes shares more appealing to external third parties making the company more attractive for acquisition. A third party making an offer for one shareholder's shares can trigger a domino effect potentially leading to buying out all shareholders making the company attractive for acquisitions.
For example, a financial advisory company had a majority shareholder with more than 70% of its shares. Due to retirement, he decided to sell his shares of the company and because of his drag-along rights, this forced minority shareholders to also join the sale resulting in all shares of the company being purchased by an external buyer. In this case the external buyer didn’t want third party investors and this clause eliminated that concern.
Valuation Clause
This clause determines the value of a company which is required for numerous situations such as mergers, acquisitions or buyouts. The total value is determined by a number of terms which can lead to the need for a valuation formula, agreed on at the creation of the agreement. Alternatively, shareholders can meet annually to discuss and agree on the value. All shareholders must have a clear understanding of the value of a company to avoid disputes when buying or selling shares.
In one case, two friends went into business together and started a moving company. 3 years later, Lauren decided she wanted to leave and sell her half of the company. Thankfully, a detailed valuation clause was included in their shareholders’ agreement. As a result of this, the assets involved were clearly laid out which avoided potential financial disagreements. They had originally decided on a payment plan and Lauren was paid in 4 installments as agreed previously with Conor. Having a well-crafted shareholders’ agreement including a valuation clause made this an easy transition for both parties leading to no personal or business relationship burdens and continued success for Conor with the business.
Non-compete Clause
The purpose of a non-compete clause is to protect both shareholders and the company by preventing insider information from being used by an exiting party. The shareholder of any company often has detailed information about business prospects, intellectual property and even competitor or customer lists and as a result of this, a carefully prepared and signed non-compete clause is vital for protecting a company from potential competition or rivalry. It’s important to specify the type of activity that classifies as competing.
For example, a tech company that provided hardware and software solutions to food, retail, and healthcare industries had their director Jack decide to leave the company as a result of ongoing conflict between the board and other issues within the company. Due to his experience, his preference was to continue his career in the same industry at a similar level. However, because of his non-compete clause, he was unable to progress his career in the same field for 2 years.
The timeframe in which a non-compete is active depends on the nature of the company and takes into consideration a number of factors such as the turnover period and acquisition process of clients.
Non-solicitation Clause
A non-solicitation clause prevents a shareholder from soliciting the company’s clients or employees for personal or company benefits. Similar to the non-compete clause, restrictions are set in place during the creation of the agreement so all parties are aware of the details involved.
This is more focused on preventing the solicitation of clients and employees rather than the prevention of direct competition that a non-compete clause offers. An example of a non-solicitation clause wouldn’t allow a previous shareholder to recruit employees or poach clients from their previous company.
In relation to the previous non-compete case, having been a director for 5 years and working at other levels in the company for a further 4 years, Jack had in-depth knowledge of business operations as well as great relationships with over 30 top clients. Due to the nicheness of their product, a temperature monitoring solution for refrigerators and freezers, and the fact they didn’t have many direct competitors active in their country made him an attractive target for competitors to recruit. The non-solicitation clause prevented the company from worrying about important information being shared with others or top clients being poached.
Shotgun Clause
A shotgun clause provides one shareholder with the ability to exit a company or force another out. This provision is included to offer a resolution for disputes by acting as an exit strategy. It creates a buy/sell provision where if the other shareholders don’t accept the offer to sell their shares, they must buy the offering shareholders' shares at the given price and terms.
For example, in a property management company that was operated by two partners, a dispute arose that resulted in one partner wanting to remove the other from the business due to a conflict of interest involving an external investor. A shotgun clause here would allow the partner to attempt to force the other out of the company. However, in this scenario, there was no shareholder’s agreement in place so a shotgun clause couldn’t be triggered therefore leading to a difficult situation causing conflict within their personal and working relationship.
By providing the means to dissolve a partnership, it’s the only clause in a shareholder agreement that can result in the forcing out of one shareholder outside of a triggering event.
The shareholder receiving the offer must decide whether to sell their shares and exit or turn the offer around and force the offering shareholder to exit. These clauses are recommended to include where parties have equal bargaining power.
Capital Expenditure Approval
Capital expenditure is a vital part of a company’s cash flow that involves the management of investments in capital assets. The CapEx process passes through multiple departments, including shareholders, before approval. Once approved, it is sent to the procurement and finance teams.
Types of Shares
A shareholders’ ownership of the business they have invested in is represented by their shares. These shares are common or preferred shares that can be purchased from the company itself or an existing shareholder.
Common Shares
Shareholders with common shares have the smallest claim proportion of a company’s assets. Common shareholders usually have voting rights and are compensated with dividends. In the event of a company’s assets being sold, those holding common shares are paid after all creditors and preferred shareholders have been first.
Preferred Shares
Similar to common shares, preferred shares are proof of the money paid into a company to company owners and other shareholders. Preferred shareholders have the right to vote and in addition, they are also prioritized over common shares. For example, if a company decides to sell its assets or goes into liquidation, preferred shareholders' rights will be addressed first before those holding common shares.
Non-voting Shares
These are shares where the shareholder will still be entitled to dividends but won’t have the right to vote or participate in company decision-making. The dividends these shareholders have can be different from common shareholders.
Assets and Shares Sales
Assets and shares are used to buy or sell a company. Deciding between asset and share sales can cause conflicting interests between shareholders but ultimately, it depends on the tax consequences and potential risks involved.
Companies in British Columbia often don’t set a limit on how many shares can be issued. Shares can be limited if the shareholders wish to restrict the chance of directors to issue shares
The shares of a company can be either voting or non-voting.
Assets
A company’s assets refer to anything owned by the company including intellectual property, inventory, cash, equipment, customer and supplier lists, contracts, and anything that makes up a business. In an asset transaction, a buyer can choose which assets and liabilities they want to acquire however, it is more common for purchasers to buy all assets and liabilities relating to the operations of a company. The benefits of purchasing assets give the purchaser the option to identify each asset individually and not acquire unwanted liabilities such as those related to employment or tax.
Buying assets at high Undepreciated Capital Cost (UCC) is the desired outcome for a purchaser because higher UCC leads to future deductions for when they acquire the company. Sometimes there is an advantage to buy shares rather than assets where the UCC is low or zero. This way, the purchaser will benefit from the Lifetime Capital Gains Exemption on an eventual sale.
As a shareholder, it’s important to be aware of the invested company’s assets as the value of these assets contributes to the overall financial success. Assets fall under 2 categories:
Current Assets
Also known as short-term or liquid assets, current assets are used by a business to pay off current liabilities usually within a 12-month period.
Fixed Assets
Often referred to as long-term or capital assets, fixed assets are used to replace and convert capital beyond the typical 12-month period that current assets are used for.
Shares
Selling shares is a preferred option for the seller as they are no longer left with unwanted assets and liabilities. They transfer all of the liability along with the sale and can enjoy the benefit of limited liability. They can also enjoy the Lifetime Capital Gains Exemption from the tax advantage of selling shares and not just assets.
When buying shares, a purchaser acquires the corporation including known and unknown assets and liabilities. This includes the possibility of inheriting tax costs. There are instances where the purchaser prefers an asset sale where they have non-capital or net capital loss available to carry forward and use against income or capital gains from asset sales.
Exit Strategies
Multiple exit strategy events are highly recommended to have in a shareholders' agreement from the onset. This keeps intentions clear for all parties involved and avoids any unnecessary future disputes when a shareholder decides to leave and the terms in which they leave. Examples of strategies to include in a shareholders agreement are:
The selling of shares to another investor
The issuing of shares through Initial Public Offering
Merging the company with another company
Conclusion
A good lawyer can help you draw up a shareholder’s agreement that addresses your concerns. A better lawyer can help you identify the pitfalls that may arise.
Our team has drawn up hundreds of shareholder’s agreements and have the expertise necessary to help you draft an agreement.
It’s important to invest time in carefully examining and reviewing a company’s objectives thoroughly when creating a shareholders' agreement. They are flexible regarding what is addressed and which provisions are included in the agreement, so carefully creating a shareholders' agreement that clearly outlines all details minimizes the risks of disagreements.
Regularly reviewing the document to keep it relevant and up to date will help avoid disputes or legal risks. For example, keeping the valuation clause updated is important because the value of a company can fluctuate.Shareholders’ agreements streamline a business by including dispute resolution mechanisms to avoid conflict within the business. They are vital to ensure that any ‘what if’ scenarios can be easily navigated and resolved should they arise. Having a shareholder’s agreement created from the start will reduce the chance of conflict between parties and offer resolution options for any disputes that arise.
It’s important to ensure this is created as soon as possible to cover all possible scenarios as these can occur at any stage during the business’ lifetime. l. Legal advice is always advised before creating a shareholders’ agreement to ensure all areas are covered as some industries may have different legal requirements to follow.
No two businesses are the same which is why a shareholders’ agreement should be tailored to the unique needs of the business greatly reducing the possibility of any unresolved disputes. We are here to simplify the process for you and give you the best advice on common practices and mechanisms involved in creating the best possible shareholders’ agreement for your business.
FAQ
What are potential problems if I don’t have a shareholder’s agreement?
Shareholder’s agreements are important for enduring that things go to plan in case a ‘what if’ situation arises. It equipts all parties involved with the information needed to make sure these scenarios are dealt with efficiently.
How do you write a shareholder’s agreement?
A shareholder’s agreement should outline the rights and responsibilities of every shareholder and the business which should be tailored to the business’ needs. Always consult a legal professional to help you write your shareholder’s agreement to make sure it covers all areas.
How can I learn more about shareholder’s agreements?
Our team are professionals in dealing with shareholder’s agreements, so don’t hesitate to get in touch!
