Creating a Shareholder Agreement: What to Include in an Effective Agreement

Introduction to Shareholder Agreements

A shareholder agreement, sometimes referred to as a stockholder agreement, is a legally binding contract that sets out the framework for how a company with multiple shareholders will operate. This essential document goes beyond the company’s articles of incorporation by detailing the specific rights, responsibilities, and obligations of each shareholder. Using a comprehensive shareholder agreement template ensures that all the shareholders are on the same page regarding key issues such as voting rights, profit distribution, and dispute resolution. By clearly outlining these provisions, the agreement helps prevent misunderstandings and future disputes, providing a solid foundation for the company’s growth and stability. Involving all the shareholders in the drafting process is crucial, as it ensures that everyone’s interests are represented and protected from the outset.

What to Think about When You Begin Writing a Shareholder Agreement

It does not matter if you are just starting a business or you have a large group of people ready to invest in a corporation, the strategies for developing a solid shareholder agreement are the same. You may have several planning meetings with potential investors simply to hash out all of the details that will exist in the agreement. You will want to consider whether you want the corporation to stay within a small circle of shareholders, or whether you will want to eventually offer shares to the public.

The shareholder agreement will have a direct impact on how decisions are made in a corporation, and this is why it is so important. While there may be a board of directors and a management team in place, everyone must work under the guidelines set by the shareholder agreement. Changing the agreement can only occur when all shareholders agree to the changes, making it even more important to set the parameters of how the business is to be run correctly the first time.

Name Your Shareholders

A shareholder agreement is a business’s contract, and all initial shareholders must be named correctly. Identify the legal name of each shareholder, the address, and the phone number of each shareholder who enters into the contract. In this agreement, you will also name any officers of the business and determine who is going to be a managing shareholder.

Specify the Responsibilities of Shareholders

The shareholder agreement is designed to avoid disputes between shareholders in an attempt to keep the business running smoothly. You can identify rules that establish how officers are appointed and how officers are terminated. In addition, this agreement should be very specific regarding the actions any officers or shareholders can take in the name of the corporation. The goal is to define expectations so that if an issue comes up, you can turn back to the shareholder agreement to determine the proper steps to take to handle the problem.

The Voting Rights of Your Shareholders

When you have a smaller company, shareholders and the board of directors might be the same people. When the business grows, it is more likely that there will be a more diverse group of individuals who manage the corporation. The shareholder agreement should establish voting rights of all shareholders and the type of vote that is required in order for a decision to be made. While some decisions may only require a majority of the shareholders, or 51%, other decisions can require a higher percentage of the majority vote in order for the decision to move forward. You can even decide if there are certain parameters that you want to leave to the sole discretion of your board of directors.

Decisions Your Corporation Might Face

As the corporation grows, there may be the need to make decisions regarding acquiring new space, purchasing property, or how to pay back a loan borrowed on behalf of the business. The shareholder agreement provides the protection you need against decisions being made by only a few members of the corporation. While it may seem tedious to outline every possible situation the corporation may find itself in, the clearer the shareholder agreement is, the easier it will be to make decisions.

Changing the Original Shareholder Agreement

It is important to take the time you need to figure out exactly what you want a shareholder agreement to say. Whereas the articles of incorporation can be changed with a majority vote of 75% of shareholders, changing the shareholder agreement requires 100% of the shareholders to agree. Trying to get 100% of the shareholders to agree on any changes can be a tedious process, and it is more useful to get your agreement done right the first time.

Determine How Stock Can be Sold or Transferred

Once the business is in existence for a number of years, there will probably be a need for stocks to be transferred or sold to another shareholder. In order to protect your share of the company, you can be as detailed as you want to be when it comes to selling or transferring stock. Within the shareholder agreement, you can make provisions that can restrict certain transfers or sales, or you can look at it from the perspective of what types of sales or transfers would be allowed. The agreement can include share transfer restrictions to protect shareholder interests, such as pre-emption rights, tag-along rights, and drag-along rights. The reasons behind such regulations include the following:

• The ability for each shareholder to control their investment in the company and protect their investment from outside influence.

• To stop external people from becoming shareholders in the corporation. For example, a provision can be written that prohibits current shareholders from selling their shares to an outside party without first giving current shareholders the opportunity to purchase the shares at a set price.

• To include how shares are handled when a shareholder dies or divorces a spouse. Shares could be transferred to a particular family member, to a spouse, or the shareholder agreement can determine that the company must buy the shares back from the estate of the shareholder who dies.

Restricting who can inherit or purchase shares in a corporation protects each shareholder. You do not want the original shareholders to find that an outside entity has come in and purchased shares, only to wreak havoc with the existing shareholders. For example, if the business is a corporation that is a family business, restrictions on who can purchase or inherit shares become very important. When you want to make sure that the business stays in the family, you have to provide ways for this to happen in a shareholder agreement. The right of first refusal, often set out in a first refusal clause or refusal clause, requires that shares be offered to other shareholders on the same terms before being sold to outsiders. This ensures that other shareholders have the opportunity to maintain their ownership percentage. Share valuation is important for determining the purchase price when shares are transferred, ensuring that transactions are fair and transparent. These provisions help ensure fair treatment of minority shareholders and protect the interests of remaining shareholders during share transfers.

The agreement can also address the admission of a new shareholder and outline the rights and obligations that come with becoming a new shareholder. It is important to specify how the company's shares are handled in these situations, including who can inherit or purchase shares. The agreement can specify how shares owned by a majority shareholder or majority shareholders are treated, and how this impacts minority shareholders, especially in the context of tag-along and drag-along rights. Exit provisions can be included to outline the process and conditions for a shareholder to exit the company, including share valuation and purchase price determination. Additionally, the agreement can specify how shares owned by remaining shareholders are affected when a shareholder exits or transfers shares, ensuring continuity and proper governance.

The Legal Obligations of Each Party in the Agreement

A successful shareholder agreement will discuss the legal obligations that each party entering into the contract must follow. Basically, the agreement is how the business will be structured, and it is the foundation on which the business will grow. You have to make it clear in writing what the legal obligations are of every person who signs the initial agreement. The agreement shall specify the rights and obligations of each shareholder in a written agreement. The parties agree to follow certain procedures if a dispute arises. While it is not possible to completely rid the corporation of future disputes, a well-written shareholder agreement can be used to settle shareholder disputes in a civil manner.

Additionally, the agreement can include provisions for resolving a shareholder dispute in good faith. Each shareholder acknowledges their obligations under the agreement, and the agreement may outline each shareholder's rights and responsibilities in detail.

The Financial Responsibilities of Your Shareholders Need to be Outlined

When the business is just starting out, it may be easy to overlook the financial considerations of the shareholder agreement. You may feel that everyone is working hard and is contributing their fair share. While this may be the case at the beginning of the business relationship, this may not always hold true. It is important to determine the amount of money each shareholder must invest in the business initially.

In addition, you will want to specify what level of commitment you will require from each shareholder. You can determine if time spent working on the business has a specific value and can be considered an in-kind commitment.

The Distribution of Dividends

How dividends are divided among shareholders is very important to shareholders, and this is an important part of any shareholder agreement. You can pay dividends quarterly, every six months, or once a year. Dividends are business profits, and how your dividends are calculated will be determined in the shareholder agreement. Dividend distribution may be based on the amount of capital stock held by each shareholder. Investors will want to know how they are going to earn money from their investment and what your plan is to distribute the money.

Developing an Exit Strategy

As you set up the business, a successful shareholder agreement will also determine what will happen in the event that the business wants to dissolve. An exit strategy should be designed as an essential part of any shareholder agreement, and this can be done in several steps. In such cases, the managing shareholder is typically responsible for overseeing the winding up process and ensuring compliance with the terms of the agreement.

• The initial step would be to figure out how shareholders would be able to get their investment back in the event the business wanted to dissolve. If only one shareholder wants to exit the agreement, this exit should not have a negative effect on the shareholders that want to stay.

• The next step is to determine if the shareholder can sell their shares, if they must hold their shares for a certain time period after announcing their plan to exit, or if they must offer their shares for sale to current shareholders only. You do not want a shareholder who gets angry with the corporation to sell their shares on a whim to anyone willing to pay.

The shareholder agreement is a contract between all the parties who sign it, giving rights and responsibilities to those who become stakeholders in the business. It is a foundation on which to build a solid business, and it will protect the interests of everyone involved if it is written correctly. When an agreement is written poorly, this can lead to disputes that are difficult to settle among shareholders and can cause individuals to potentially lose their fair share of the business.

In witness whereof, the parties hereto have executed this agreement, and any transfers or obligations relating to shares must be executed in the same instrument to be valid.

Dispute Resolution Mechanisms

Dispute resolution mechanisms are a vital part of any shareholder agreement, as they provide a clear process for resolving disputes that may arise between shareholders. Rather than resorting to costly and time-consuming litigation, shareholders agree to use alternative dispute resolution methods such as mediation or arbitration. These methods are designed to resolve disputes efficiently and fairly, preserving the business relationship and minimizing disruption to the company. The agreement should specify the procedures for dispute resolution, including how mediators or arbitrators are selected and which governing law will apply. By establishing these mechanisms in advance, the shareholders can address future disputes with confidence, knowing there is a structured process in place to resolve disputes and maintain the integrity of the company.

Governing Law and Jurisdiction

Including a governing law and jurisdiction clause in your shareholder agreement is essential for ensuring clarity and consistency in how the agreement is interpreted and enforced. This provision specifies which state or country’s laws will govern the agreement and where any disputes will be resolved. All the parties to the agreement agree to submit to the jurisdiction of the chosen courts, which helps avoid confusion and potential legal challenges down the line. Selecting a governing law that is familiar and accessible to all the parties involved can streamline dispute resolution and provide a fair legal framework for the company’s shareholders. By addressing governing law and jurisdiction upfront, the agreement helps protect the interests of every shareholder and supports the smooth operation of the business.

Confidentiality and Non-Compete Clauses

Confidentiality and non-compete clauses are critical for safeguarding the company’s sensitive information and competitive position. In a well-drafted shareholder agreement, each shareholder agrees to keep all trade secrets and proprietary information confidential, ensuring that such information is not disclosed to outside parties. Additionally, a non-compete clause restricts shareholders from engaging in or supporting any business that competes with the company, either directly or indirectly. These provisions are designed to prevent unwanted external influence and protect the company’s long-term interests. By including robust confidentiality and non-compete clauses, the agreement helps maintain trust among shareholders and secures the company’s valuable assets.

Importance of Professional Advice

When creating a shareholder agreement, it is essential for all the shareholders to seek guidance from a qualified law firm with expertise in corporate law. Professional legal advice ensures that the agreement is tailored to the company’s unique needs and complies with all relevant laws and regulations. A law firm can help draft provisions that address the specific rights and obligations of each shareholder, reducing the risk of future disputes and ensuring the agreement is enforceable. Relying on a generic template may leave important issues unaddressed, so it is always best to consult with an attorney who understands the complexities of shareholder agreements. By investing in professional advice, shareholders can create a comprehensive and effective agreement that supports the company’s long-term success.

How to Create a Shareholder Agreement

Use our customizable shareholder agreement template to create, download, and print your shareholder agreement in just minutes online.