Tips on Shareholders’ Agreements
Everyone’s got one (or probably should have one): some essential things to know about shareholders’ agreements.
|We had the pleasure of speaking about shareholders’ agreements at the 2019 rendition of The Six-Minute Business Lawyer presented by the Law Society of Ontario yesterday. Here are some essential things to know about shareholders’ agreements:
(a) What’s a shareholders’ agreement? Shareholders’ agreements generally cover four main areas: (i) how decisions in a company get made; (ii) how money comes into a company; (iii) how money goes out of a company; and (iv) how shareholders exit (or transfer their shares).
(b) Do I really need a shareholders’ agreement? According to a litigator friend of the firm, the number one reason (“by a mile”) why people sue each other in connection with a shareholders’ agreement is when there is no shareholders’ agreement in place at all. So, while some shareholders’ agreements are better drafted than others, simply putting one in place can significantly reduce the risk of litigation later on. (Thanks Bryan McLeese!) The mere process of preparing a shareholders’ agreement often prompts people to consider and agree in advance on aspects of their business that they might not otherwise have thought about.
(c) What should a shareholders’ agreement look like? There is no such thing as a “standard” shareholders’ agreement – the business deal should drive the document. The shareholders of a company have already formed some agreement as to how the company will be run; it’s the job of the lawyer to understand what that agreement is and make sure the documents reflect it. The lawyer should also poke and prod to make sure that all the details are thought through, and ensure that even unlikely and unpopular possibilities are considered (what if you and your best friend don’t agree on business strategy? What if Aunt Martha does decide she wants a seat on the board after putting up the initial funding?).
(d) What if we don’t know all the details yet? The substantive details don’t all need to be worked out up front – the shareholders’ agreement can delegate them to the board or the shareholders later on. If the client wants to put a budget in place, for example, the shareholders’ agreement can simply provide that the board of directors can approve budgets for the company (and the actual budget can be prepared and presented to the board later on).
(e) What if shareholders are supposed to help out or contribute services to the company? Shareholders who will be providing services to the company can enter into separate employment agreements or independent contractor agreements with the company, which has the added benefits of a) keeping their duties and terms of engagement private from future shareholders, and b) allowing for the amendment of that contract without needing to amend the whole shareholders’ agreement and needing to get many other shareholders to agree to that.
(f) What are hot-button issues to look out for? Every company and group of shareholders is unique. Some factors that could be important for your shareholders’ agreement could include:
(i) Board nomination rights. These can shape how a board of directors will look for years to come, even if the original founders of the company get diluted down to minority positions. Pay attention to the conditions for nomination rights – should a person need to continue to hold a certain number of shares in order to nominate someone to the board, for example?
(ii) Tag-Along and Drag-Along Rights. Tag-along rights provide minority shareholders with greater liquidity and protection if other shareholders are selling their shares, but can make it more difficult for a larger shareholder to sell. Drag-along rights prevent a minority shareholder from blocking the sale of a company that is supported by the majority shareholders. Remember to look at the company’s cap table to understand how the shareholder thresholds for the engagement of these rights is likely to affect the client. For example, if the client has 90% of the shares today and wants to be able to drag along the other shareholders on a sale transaction for a while to come, you might have the drag-along provision be activated by shareholders holding 85% or 80% of the shares to allow the client to unilaterally exercise it even after some dilution.
(iii) Voting obligations and consent rights. Shareholders may be obligated to vote for certain things, or may be deprived of their ability to vote entirely; this could be really important or not at all important to your client, so make sure to ask. Shareholder consent may be needed for certain corporate actions; this kind of consent requirement can empower shareholders at the expense of the board, and these provisions should be carefully reviewed to make sure they reflect the business deal. You can also require consent from only certain shareholders, or shareholders holding only a certain proportion of shares, to avoid the need to chase after little shareholders for signatures on a resolution.
(g) What else needs to be checked when preparing to put a shareholders’ agreement in place? Look at the company’s articles for share classes and transfer restrictions. Look at the by-laws for governance matters and make sure it’s clear if the shareholders’ agreement is meant to override the by-laws. Of course, the corporate law that applies to the company (OBCA or CBCA) should be checked to understand which provisions may be overridden by a shareholders’ agreement. And finally, make sure you understand the whole structure of the company and the relationships between the shareholders.
(h) Who needs to get their own independent advice on a shareholders’ agreement, and which kind?
(i) Independent Legal Advice. Every other party to the shareholders’ agreement needs to get their own independent legal advice on it. If the shareholders’ agreement is being drafted by counsel to the corporation, for example, each shareholder should get legal advice on it from their own lawyer.
(ii) Independent Tax Advice. Because a shareholders’ agreement deals with the movement of money (money coming into and flowing out of a company), shareholders should also get their own tax advice on the shareholders’ agreement. A tax professional should also weigh in on whether the shareholders’ agreement could affect the company’s ability to remain a Canadian Controlled Private Corporation, or CCPC – an advantageous tax designation.