Disputes among shareholders of privately-held companies are more common than most people realize. As lawyers, we see a pattern of individuals setting out to start a business together as “partners”, and incorporating a company with not much more than a set of standard incorporation documents.
If there is no formal agreement further defining the rights and obligations of each shareholder in relation to each other and to the company, there is a risk for parties to backtrack on previous verbal understandings or for disputes to arise from circumstances that had not been contemplated at all. Problems and disagreements typically begin to appear once the honeymoon phase of starting a new company has ended.
A well-drafted shareholders’ agreement, one that takes into consideration the nature and structure of the business, will help to alleviate some of these risks and provide guidance in the event of disagreement.
A shareholders’ agreement can help you clarify the following matters:
- Management of the company and role of the shareholders
- Identifying shareholders that will also be directors, officers, and/or employees of the company and explaining compensation structure
- Responsibility for day-to-day management
- Decision-making process for major decisions affecting the company
- Banking and Financing
- Designating individuals with banking authority
- Deciding how much money the company will need
- Determining shareholders’ required contribution amounts and timing of contribution
- Terms for repayment of shareholders’ loans
- Distribution of net profits and payment of dividends
- Terms for obtaining third-party financing
- Restrictions on transfer or issuance of shares
- Mechanisms such as rights of first refusal, drag-along rights, and piggy-back rights (most shareholders of privately-held companies do not want the other shareholders to be capable of freely transferring shares in the company to third parties)
- Restrictions on share issuance to prevent dilution of shares
- Duties and Obligations
- Duty of confidentiality regarding private company information
- Duty of non-competition with the company and other shareholders
- Non-solicitation of company customers, suppliers, or employees
- Dealing with Specific Circumstances
- Events such as death, incapacity, retirement, or bankruptcy of a shareholder
- Remedies available when a shareholder breaches the Shareholders’ Agreement
- Dispute Resolution Mechanism
- Process for resolving any disagreements and responsibility for costs
- Resolving deadlocks and compulsory buy-out
- Options for negotiation, mediation, and arbitration
Having a properly drafted shareholders’ agreement is an important preliminary step that will help set your company on the right path and let you focus on building your company’s business.