The Shareholders Agreement

When a company is created, the original shareholders determine how the company will be owned and managed.  This is often set out in a written contract amongst the shareholders called a shareholders agreement.  There is no legal requirement for the shareholders to enter into a shareholders agreement but in the absence of a shareholders agreement the company will be governed by the basic provisions contained in the applicable corporate statute (i.e. the Ontario Business Corporations Act or the Canada Business Corporations Act) together with the company’s articles of incorporation and by-laws.  In most cases these force the sale of shareholder’s shares, this can result in companies becoming dead locked or unable to react in a timely manner to pressing business issues.  Therefore it is desirable for a shareholders agreement to be entered into in order to provide a more detailed set of “ground rules” which are specifically tailored to the circumstances of the company and the shareholders.

There is no such thing as a “one size fits all” approach to preparing a shareholders agreement.

Careful planning and consideration must be given by shareholders and counsel in order for the agreement to address issues which arerelevant today and plan for the various scenarios that could potentially arise throughout the life of the company.

Matters often addressed in a shareholders agreement include:

1. General Decision Making

    • Which decisions are to be made by shareholders and which decisions are to be made by the directors? (i.e. corporate decisions vs. operational decisions)
    • How are decisions made? (i.e. majority vote vs. super majority vote vs. unanimity)
    • How are disputes resolved?
    • Who has the right to be on the board of directors or to nominate a director?
    • Is the agreement a “unanimous shareholder agreement”? (i.e. restricting the rights of director by the shareholders)
    • Who is permitted to sign cheques and contracts on behalf of the company?

2. Financing the Company and Distributing Profits

    • How is the company financed? (i.e. loans vs. equity)
    • Is third party financing permitted?
    • What if personal guarantees are required?
    • How and when are profits distributed?

3. Share Transfer Restrictions

    • Are transfers permitted in certain circumstances? (i.e. family members, holdings companies or family trusts)
    • When can further shares be issued?
    • Are there anti-dilution protections?

4. Liquidity

    • Are there Shotgun or Buy Sell provisions
    • Rights of purchase on death or permanent disability of a shareholder
    • Rights of first refusal
    • Sales to third parties
    • Other liquidity events (i.e. bankruptcy, termination of employment, Family law Act claims by spouses)
    • Confidentiality, non-competition and non-solicitation restrictions following a sale of shares

Again, the above is a very brief overview of some of the matters to be contained in a shareholders agreement.

Often when dealing with a start-up company with limited financial resources, a shareholders agreement may be viewed as an unnecessary expense because it does not contribute to the immediate success of the underlying business.

Start-up shareholders often cannot foresee the consequences that a future dispute will have on the operation and value of the business or consider it unlikely that such a dispute will ever arise.  It is my experience that one of the biggest mistakes which entrepreneurs make is not entering into a shareholders agreement.  Although the immediate value of a shareholders agreement is difficult to quantify its importance should not be discounted.

Entering into a shareholders agreement at the early stages of a company will help the founders to develop a common understanding regarding their roles and contributions to the company and will turn their minds to issues which are relevant at all stages of the business which they otherwise would not have considered as a group.

Conclusion

Very careful consideration should be given to the matters that are contained and outlined in a shareholders agreement.

Having advised clients for the last 30 years, Joseph A. Truscott Chartered Accountant is very experienced in providing input to his clients and their solicitors of some of the various matters that should be addressed in a shareholders agreement.  In addition, careful consideration must be given to the income tax ramifications of various matters outlined in a shareholders agreement.

Generally, it is advisable to have a shareholders agreement in place when the company is commenced.  Leaving these matters until a later time only complicates the process.

If you have any questions regarding your shareholders agreement or require assistance in the preparation of such an agreement please feel free to call Joseph A. Truscott at 905 528-0234 or by e-mail at; joetruscott@josephtruscott.com.