When there are two or more shareholders in a corporation, they should consider drawing up a shareholder agreement. This document explains what is to happen in the event of a disagreement between the parties. In some corporations, the minority shareholders have a risk of being locked into a long-term enterprise with little or no way to withdraw their capital. Even family corporations should consider a shareholder agreement, since it could settle some issues without the expense of litigation.
A shareholder agreement is a fairly complicated document and should be drawn up by an attorney. This may be costly, but the expense should be weighed against the costs of lengthy litigation should the parties break up.
When drawing up a shareholder agreement, you will consider your options during the expansion of your company, but be sure to also consider the possibility of negative events, such as bankruptcy or death of a participant. These are the times when a shareholder agreement is most needed.
Rights of Minority
The biggest risk in a small corporation with unequal ownership is that an owner of a minority interest will be shut out of making decisions. Unless some rights are spelled out in a shareholder agreement, any shareholder with less than 50% interest risks having his or her investment tied up indefinitely. Many of the clauses in a shareholder agreement address various rights (such as salary and withdrawal) of shareholders with a minority interest.
Supermajority Vote or Unanimous Consent
In order to allow shareholders with minority interests to have a say in major changes in the corporation, you can require unanimous consent or more than simple majority vote (supermajority) on such issues. One danger to keep in mind is that requiring unanimous consent can allow one disgruntled shareholder to sabotage the efforts of the majority.
Example: If the majority wants to sell the company, you would not want one shareholder with 10% interest to kill the deal. You should seek an agreement that can balance the rights of the majority and the minority. If a 10% owner is the only one who does not want to sell, then he or she can be given the right to buy out the other 90%.
Devoting Best Efforts
One problem that sometimes comes up in the life of a corporation is that one shareholder loses interest and no longer contributes the time that was originally expected. Another problem may arise when a shareholder becomes a part of a competing enterprise. To avoid disagreements, you should spell out what is expected of each shareholder. You could spell out how many hours a week each person is expected to work, or you could just have a general agreement that each shareholder will devote his or her best efforts to the company.
Right to Serve as Director
A very effective protection for minority shareholders is the right of each to serve as a director. This enables them to take part in directors' meetings without being elected and to stay informed of activities of the corporation. However, being a director does not guarantee a right to control decisions.
If there is a chance that some of the shareholders will later vote themselves higher salaries than others, you can include an agreement as to what the salaries will be and include a requirement that any change must be agreed to by everyone or by more than a simple majority.
Nominating Officers and Employees
One common provision in a shareholder agreement is to agree on what office will be held by each shareholder. Any change could require unanimous consent or a supermajority vote. However, be sure to provide for the possibility that someone may become unable or unwilling to do the job.
A way to end a dispute between shareholders is to provide for a compulsory buyout. This can be open-ended, in which either party can buy out the other, or it can be specific, in which one person's shares are subject to a buyout. A formula for determining the buyout price should be in the agreement, to avoid disagreements later.
Transfer of Shares
Most small corporations limit the ability of shareholders to sell their shares. This protects the corporation from violations of securities laws and from persons whom they might not want as shareholders. A limitation on the ability to sell shares is usually combined with a buyout plan.
To maintain a balance of power among the shareholders, it is important to have provisions covering the issuance of new shares or a merger with another corporation. Besides a clause that provides a majority or unanimous consent for decisions concerning these events, a provision to issue new shares on a pro rata basis can solve some situations.
Transfer of Substantial Assets Endorsement
To protect the shareholders' value, a clause can be added that any transfer of substantial assets for any consideration other than cash is not allowed.
An endorsement on the shares informs a potential transferee about the circumstance that the shares are subject to certain restrictions concerning their transfer. It warns the transferee and betters the chances of the corporation in case of a lawsuit due to a transfer not being in accordance with the provisions of the shareholder agreement.
To avoid any misunderstanding, the formalities as to how the shareholder agreement should be complied with can be included.
Because going to court is so expensive and can take years, it is a good idea to put an arbitration clause in your agreement. Arbitrators, who mediate legal disagreements and issue decisions on them, are often lawyers or former judges, so you get a decision similar to what you would have gotten in court, without the expense or delay.
Most shareholder agreements contain standard legal boilerplate language, such as entire agreement (there are no verbal additions to this agreement), severability (if one clause is invalid that would not be reason to throw out the entire agreement), and choice of law (which state's laws will be used to interpret the agreement).