The Shareholder Agreement: What is it and is it Necessary?

Going into business with other people, no matter who these other people might be (i.e. your best friends, your siblings, your parents, or anyone else) is always a risky venture. When most people choose to go into business with one another, they cannot imagine a breakdown of their relationship (this is even truer for families and friends). However, as businesses rise and fall, these relationships can, and unfortunately often do, turn. If these relationships do inevitably turn, people are often overruled by emotions and reasonable decision making frequently gives way to anger.

A Shareholder Agreement is a contract signed between two or more shareholders of a corporation or a contract signed between the corporation itself and either some or all of its shareholders. It sets out the foundation for how the parties are to interact with one another. A well drafted Shareholder Agreement clearly identifies the parties’ expectations and responds to their concerns.

Shareholder Agreements are meant to guard against the risks of a free-for-all in the event of a relationship breakdown and to protect the shareholders and the corporation by managing some of the risks that the future may bear.

While the Shareholder Agreement in itself is a flexible document which can be tailored to any corporation and group of shareholders, a proper Shareholder Agreement would clearly speak to all of the following issues:

  1. It would create a road map for resolving future conflicts between the parties (such as mechanisms for resolving negotiation deadlocks) while providing the parties with incentives for resolving their disputes amicably;
  2. It would anticipate future events both in the life of the corporation and in the lives of the shareholders and it would set out the strategy for dealing with the said events (good examples of some of these would be changes in corporate ownership and shareholder death);
  3. It would clearly set out the parties’ rights and obligations (specifically, it would precisely delineate the parameters for corporate management, control and share transfer);
  4. It would stipulate how shareholders are to vote and set out restrictions on when, how, and if new shareholders could join the corporation; and
  5. It would give the parties a jumping off point in dealing with unexpected events (such as clearly identifying how a shareholder exit might be handled under various circumstances).

In order for a Shareholder Agreement to be current and relevant at all times, it must be fluid and adaptable. Specifically, it must accommodate and allow for quick action when an unanticipated event arises. However, it must also be clear enough that whenever necessary, any party could turn to it and be certain about the action to be taken.

Forward thinking business owners quickly realize that it is crucial to have a Shareholder Agreement drafted and executed as early in the corporation’s life as possible (especially as it can always be amended, if necessary, with time and the addition of new parties). If prepared early, the parties are often forced to consider circumstances they would not have otherwise considered. This often allows them an opportunity, at the outset, to truly evaluate whether they would like to continue this venture as well as to deal with contentious issues and potential future events when the relationship is still amicable.

The result, as the corporation begins (or continues) to operate, is almost always a better managed corporation (and a more seamless transition for new entrants), a sort-of harmony among parties in decision making, a more reasonable resolution of disputes, and more amicable exits.

So to answer the question: “is a Shareholder Agreement necessary?” While it is definitely advisable, with respect to necessity, you would have to decide for yourself.

DISCLAIMER: This article should not be interpreted as providing legal advice. Consult your legal adviser before acting on any of the information contained in it. Questions, comments, and suggestions are most appreciated and should be directed to:

Svetlana Ora Shpigelman, B.A., J.D. is the principal lawyer at SOS LAW. SOS LAW specializes in all areas of business law, including corporate structuring and governance. For more information, visit our website or call us at 647-931-5012.

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