Key Elements of a Strong Shareholders’ Agreement

A shareholders’ agreement can go a long way in helping set up your business for long-term success. Thinking about unpleasant situations is never fun but it will help in the long run if and when these situations arise. Putting in place a shareholders’ agreement will equip you and your fellow shareholders with the necessary tools to tackle those situations. Here are some elements that should be included in all agreements.

Process for appointing directors and their duties

This section should outline how directors will be appointed. Some examples include each shareholder appointing a director, each class of shares appoints a director, or appointing them through a majority vote. Potential investors may also want a representative on the board, so that must be considered. The responsibilities of the directors should also be laid out clearly.

Matters requiring unanimous consent

Putting together a list of matters that require unanimous or a special majority can greatly improve the strength of your agreement. It will clearly lay out the requirements making the process much more efficient.

Shareholders’ rights

This section is also really important as it outlines the ways in which shares can be bought, sold, issued, and distributed by shareholders. There are a number of provisions that you may want to include in your argument, such as pre-emptive rights, rights of first refusal, draw along rights, put/call provisions, and a shotgun clause to name a few.

Pre-emptive rights

This allows the shareholders to avoid dilution of their stake in the business. This right allows shareholders to purchase newly issued shares before anyone else.

Right of first refusal

This right is used to protect current shareholders and discourage third-party purchasers. If an existing shareholder receives a purchase offer for his/her shares, that shareholder must first present that same offer to the other shareholders. If the other shareholders do not match the offer, the shares can then be sold to the third-party.

Draw along rights

these rights are in place for when a third-party offers to purchase a majority of the shares, the majority owners can require the minority owners to sell their shares.

Shotgun clause

is essentially a forced buyout and can be used to resolve disputes.

Share valuation

It is important to dedicate a section to the share valuation so that any disputes can be resolved easily. Such a clause would require shareholders to determine the value of their shares (annually or bi-annually). It would also be important to include the process by which the valuations will be made.

Provisions for Death, Divorce, Disability and Dispute

These provisions are at the core of a shareholders’ agreement. Anyone going into business with other shareholders should be thinking through what could happen if any of the above events occurs. A shareholders’ agreement is essentially a plan to deal with the inevitable difficulties in life and business. There are a variety of ways to address these future events, and thinking through them before they actually occur is good insurance for your company.

Although a shareholders’ agreement is not required, the lack of one can be the reason your business ultimately fails. Consulting a small business lawyer is highly recommended to ensure you and your business are set up for success.