What is a Shareholder Agreement?

What is a Shareholder Agreement?

A shareholder agreement is a contract between the shareholders, or the owners, of a company. A unanimous shareholder agreement is a contract between all of the shareholders of a company.
Shareholder agreements often set out the rules of the game for the shareholders and typically include the understanding of the shareholders of their respective roles in the company, their obligations to the company and to one another, the limitations on their freedom to transfer their shares, exit strategies and the categories of decisions that should require the approval of more than 50% or sometimes all of the shareholders of the company.

What to Include in Shareholder Agreements?

Good shareholder agreements are customized to reflect the circumstances of the corporation and the wishes of the shareholders and so the answer is: it depends. However, below are some of the provisions that commonly appear in many shareholder agreements:

Shotgun (Buy/Sell) Clause

A shotgun clause is used when a shareholder no longer wishes to work with the other shareholder(s). It is an interesting arrangement that allows the unhappy shareholder to provide an offer to the other shareholder(s) and force them to select one of the following two options:

  1. to sell their shares to the shareholder exercising the shotgun at a certain price per share; or
  2. to buy the shares of the shareholder exercising the shotgun at the same price per share.

The shareholders who receive a shotgun offer are usually provided with a 20-30 day period to accept one of the two offers. If none of the offers are accepted, the shareholder who has exercised the shotgun will typically get to buy the shares of the other shareholder(s) at the price that was offered.

Right of First Refusal

In order to make sure that the ownership of the corporation remains within the shareholders and to prevent others from entering the corporation as shareholders, often a right of first refusal clause is inserted in the shareholder agreement. A right of first refusal clause will essentially require any shareholder who plans to sell his/her shares to a third party to first offer those shares at the same price as the anticipated sale to the third party to the other shareholders. The shareholders receiving the offer will then be provided with a period of time to accept the offer. If the offer is not accepted within this timeline, the selling shareholder will be permitted to sell his/her shares to the said third party.

Pre-Emptive Rights

Dilution is always a concern for shareholders. When the corporation issues new shares, the total number of shares in the corporation increases and the shareholders who do not receive the newly issued shares get diluted as they end up owning a smaller percentage of the shares of the corporation. To avoid this issue the shareholders often include a pre-emptive rights clause in the shareholder agreement requiring the corporation to provide the shareholders with an opportunity to purchase their pro-rata portion of any new shares that are issued by the corporation in order to avoid dilution.

Non-Competition & Non-Solicitation

In small to medium-sized companies, shareholders often play a more active role in the operation of the business and may not be comfortable with the idea of one of the shareholders investing in a competing business. In these circumstances, a non-competition clause is included in the shareholder agreement in order to ensure that the shareholder will not engage in a competing business within a set period of time and within a defined geographic scope. A non-solicitation clause would on the other hand prohibit the shareholders from soliciting any of the clients or employees of the company for the purposes of engaging them in another business.

Matters Requiring Specific Approvals

Shareholders entering into shareholder agreements should think about categories of decisions that they do not wish the company to make without their approval. These are usually important and substantial decisions such as changing the nature of the business, filing for bankruptcy, borrowing substantial sums of money on behalf of the corporation or selling all of the assets of the corporation but depending on the circumstances and the nature of the business can include other types of decisions. Shareholder agreements usually include a clause that lists the types of decisions that require either a unanimous approval by all of the shareholders or the approval of 2/3 of the shareholders.

Equity Investment

Many shareholder agreements include a section, typically containing a table, which will set out the number and the class of the shares issued by the corporation to each of the shareholders as at the date of execution of the shareholder agreement. While this information should also be recorded in the shareholder register of the corporation’s minute book, it is also a good idea to set out the details of the equity held by each of the shareholders in the shareholder agreement in order to avoid any potential disputes in the future as to the amount and type of equity held by each of the shareholders.

When do I need a Shareholder Agreement?

Generally speaking, so long as a corporation is not wholly owned by one individual, it is recommended that the shareholders draft and execute a shareholder agreement reflecting their understanding of their respective rights and duties. An appropriate shareholder agreement will eliminate surprises and lengthy and expensive litigation by clearly setting out what the shareholders will need to do in circumstances which can turn into matters of dispute.
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