Shareholder Agreements - The Basics

By: Josh Sud | Queen’s Venture Law Society | December 2021

Editors: Nicolas Guevara-Mann, Mikela Page, Jakob Wildman-Sisk

Thinking of incorporating a business? To avoid messy control issues down the road, one of the most important things you can do for your corporation is to create a shareholder agreement (SHA). A SHA is an agreement that summarizes the rights of shareholders, as well as the relationship they have to one another and to the business. Importantly, it can help resolve future disputes. This is because SHAs typically outline how to resolve common issues that arise within the context of a company. In sum, the purpose of a SHA is to ensure shareholders are treated fairly and that their rights are protected. The following provides some essential content an aspiring business owner should consider including in their company’s SHA.

What Should Be Included?

There are no formal requirements for a SHA other that it be in writing and be signed by those shareholders that are party to it.^[1] However, SHAs generally cover certain areas, such as the following:

1. Governance and Decision-making: How will business decisions be made and by whom?
2. Adding Shareholders: How can someone become a shareholder?
3. Leaving Shareholders: How can a shareholder leave the company? What will happen to their shares?
4. Compensating Management: Who will be compensated, for what, and how?
5. Returns on Investment: How will shareholders’ investment yield returns?[2]

Share Transfer-specific Clauses

Clauses regarding treatment of shares are some of the most important clauses in a SHA. A share provides a bundle of legal rights to each shareholder^[3] which enables a shareholder to derive value from their shares in multiple ways. For example, shareholders can be eligible for dividend payouts. They can also sell their shares, which is called a “share transfer”. Share transfer clauses in a SHA are essential to protecting the business and shareholders from unlawful or disadvantageous share transfers. Below are a few important share transfer clauses to consider adding to your SHA:

1. Right of first refusal: These state that the company has the right to purchase a selling shareholder’s shares before they can sell to an outside party. ^[4] This can be advantageous to business owners looking to maintain sufficient control over their company.
2. Shot-gun clause: This allows a shareholder to offer to buy the shares of another shareholder for a stated price per share. If the second shareholder chooses not to accept the offer, they are obliged to buy the offering shareholder’s shares at the same price.^[5] This is an extreme mechanism that is most commonly used when the business operations of the corporation are in distress.^[6]
3. Call option: These allow companies to purchase shares back from a shareholder when a certain ‘trigger event’ occurs (for example, the shareholder leaves the employment of the corporation). This protects the corporation and allows them to maintain control over who becomes a shareholder.^[7]
4. Put option: Like a call option, these are triggered by events. When these “trigger events” occur, these clauses entitle any shareholder to sell their shares back to the corporation and oblige companies to re-purchase the shares. These clauses can protect individual shareholders but restrain companies who are required to expend capital even if they are not prepared to do so.^[8]
5. Tag along rights: If a majority shareholder sells their shares, these clauses allow minority shareholders to ‘tag along’ to the transaction and sell their shares for an identical price.^[9] These are sometimes referred to as “co-sale rights”.
6. Drag along rights: These clauses force shareholders to sell their shares in a given transaction, such as a take-over bid. A majority shareholder opting to sell can ‘drag along’ minority shareholders into also selling their shares.^[10]

How a company structures its SHAs should reflect the unique qualities of each business. Each company should work closely with a legal advisor to develop an agreement that works best for its unique structure. A well-drafted agreement will protect the business from future disputes and establish clear rights and responsibilities of its individual shareholders.

 

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