What is a Shareholder’s Agreement?
These agreements are some of the most notorious agreements because they are very challenging for clients to actually get around and sign. They’re very long. There can be 15 to 60 Pages. They contain a lot of language that is very difficult for a non-practitioner to understand and they just seemed like something that just gets pushed to the end of the list. It’s one of those things that you know is good for you but you just don’t want to get done. It’s kind of like going to the dentist.
So let’s take a look at these agreements because while they’re not all that sexy they’re extremely important and they can be essential to the success of your business over the long haul.
So the sad fact is that many businesses don’t have shareholders agreements just like my friend and the reality is that a business arrangement is really no different than getting married. When you get married you’re sharing your finances and you’re agreeing to spend a lot of time with that person and when you go into business you’re sharing your finances usually or at least you’re marrying your financial outcomes to that other person and you’re agreeing to spend even more time with that person. So it’s an extremely intimate relationship and a lot of people when they get married they recognize that 50% of marriages don’t work out might be a good idea to get a prenuptial agreement or a marriage agreement just in case and unfortunately, a lot of people go into business together and despite the fact that 90% of businesses will fail.
They don’t get a shareholder’s agreement. They don’t think through those long-term scenarios of what happens if somebody wants to get out, somebody decides they are more interested in a different business opportunity if they want to sell their shares to a third party or if something horrible happens – if they die, if they become permanently disabled, if something else happens that makes it impossible for them to contribute to the business anymore. So those are all scenarios that really need to be thought through and thought through very carefully and the best time to do that is when the parties are happy with each other when the business is first starting out when they’re in the honeymoon stage.
If there’s no such mechanism in place and nobody’s able to come to an agreement on what they think the value of the shares are then the company might just flounder and end up sinking and both parties would lose the value in the company.
Some shareholder’s agreements have default provisions, where if one shareholder fails to do certain things if they breach a term of the shareholder’s agreement if they are fired as an employee or as a contractor of the company. If they fail to fulfill on certain milestones, then they can be considered to be in default of the shareholder’s agreements and if they’re in default then that can trigger certain remedies. One of those remedies could be a mandatory buyout at a discount. It might force that shareholder to sell his or her shares at an 85% or 90% valuation and the shareholder’s agreement also speaks to how to value the shares. There’s a mechanism, there’s a process for determining what the fair market value of the shares is going to be. All these things are incredibly useful because, in a time of the dispute, it’s very difficult to come to an agreement on who should sell what shares to whom and what they’re actually going to be worth.
What happens in the event of somebody dying?
A shareholders agreement also handles what happens in the event of somebody dying and this is a subject I’m going to explore in further detail in a later video. But in essence, what happens there is one shareholder may be left with the estate handling owning the shares of the person who just died. And in that event again, you might have a very awkward situation where the estate thinks, “Hey, you can buy the shares out, but they’re worth a hundred thousand dollars.”
Whereas the shareholder says, “No, I think they’re worth $10,000,” so very difficult situation to resolve and that is something that a shareholder’s agreement is going to address. There are a variety of other scenarios that one of the shareholders commits fraud if they commit some other kind of felony if they go bankrupt or if they actually get divorced and then some of their shares are going to the hands of their ex-spouse what happens in that scenario? Nobody wants to be in business with their business partners ex-spouse not a good recipe for the long-term success of the business.
Shareholder’s agreements, are long. They’re boring. They’re complicated but they’re also very very important and they are a sign that you are committed to the long-term success of your business and frankly to the long-term success of yourself as a business person. So if you have any questions about shareholders agreements,
Please don’t hesitate to reach out happy to chat about them and thank you very much for watching.
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