What is a Shareholder Agreement?

January 31, 2024

Whether a corporation contains one or more shareholders, a written agreement is ideal to define roles and responsibilities, help minimize conflicts, and encourage cooperation and progress. A shareholder is an individual or legal entity that owns at least one share in a company. A shareholder agreement will generally provide the shareholders’ rights and interests, roles, and obligations. Additionally, it will state how certain disputes or other matters will be resolved such as procedures after the death of a shareholder and restrictions on the sale or transfer of shares.

Although not legally required, here are a few provisions to consider including in your shareholder agreement.

1.       Voting Rights and Distribution Rights

A shareholder agreement can provide the types of corporate actions that will require approval by either all or a specific percentage of shareholders. Typically, shareholders vote by majority vote. Additionally, a distribution policy can be included to detail when and how corporate profits will be distributed to shareholders. Given that a company’s financial circumstances can fluctuate, a corporation can designate a minimum requirement or condition that must be met prior to making a distribution. For example, a corporation is not required to make a distribution during the term if shareholders are not able to pay their taxes attributable to the corporation.

2. Share Transfer Provisions

With a right of first offer, a shareholder must first solicit offers from other shareholders prior to selling their share(s) to a third party. Until the selling shareholder informs the remaining shareholders of the terms of the sale and waits for them to turn down or refuse the right to purchase the shares for sale, then the selling shareholder can proceed with the sale to the third party. This is referred to as the right of first refusal.

3. Buy-Out Rights

The company or other shareholders are given the right to purchase shares owned by another shareholder if certain events occur. These events can include but are not limited to, disability, divorce, bankruptcy, or a divorce. This provision can also set the price that must be paid for a shareholder’s interest in the business or restrict outside third parties from purchasing the shares.

4. Deadlock Provisions

When shareholders cannot agree on a specific decision or the next course of action and no “tie-breaker” exists, a deadlock usually results. In this case, shareholders will agree upon certain events that will resolve the disagreement. Such events can include the requirement of mediation, offering to sell or buy out other shareholders’ stock at a specified price, or another conditional termination term.

5. Purchase Price

Whether the purchase price requires an “all cash” purchase price or allows for purchase with a promissory note, specific terms can be included to set how shares can be purchased. The value of the shares could be determined by a formula or based on fair market value. A shareholder agreement can also specify the term of the note, interest rate, and collateral, if any.

Whether a start-up or larger company, a shareholder agreement is essential to maintain control over the business as well as minimize risks and potential litigation. Keep in mind that terms in the shareholder agreement should be consistent with other corporate documents including the articles of incorporation or bylaws. Every corporation is different and may require certain provisions to further protect their rights and interests, so it is important to seek legal counsel for additional assistance.

All information provided is strictly educational and does not constitute legal advice. Any past or previous results do not guarantee future outcomes as results may vary. For legal advice, please consult with a licensed attorney.