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Posted on February 21st 2006 in Legal Articles

PUT IT IN WRITING – The importance of shareholder agreements

PUT IT IN WRITING – The importance of shareholder agreements

When setting up a business there are three formats to consider – sole proprietorship, partnership and incorporation. Each has advantages and disadvantages depending on the particular circumstances.

When two or more people are going into business together, they must obviously choose between partnership and incorporation. Regardless of which route is chosen, it is essential to put the agreement, that will govern the relationship, in writing. While things may seem all bright and rosy at the start of a new venture, it is surprising how quickly they can turn sour. Remember an agreement is probably of greater value when things go wrong than when they do not.

If you and your business partners decide to incorporate, you should consider entering into a shareholders’ agreement. This document will cover a wide variety of issues. Although a lawyer will probably assist you to draft the agreement, you should start to think about the various items that you may want to include.

This exercise can prove tricky since many of the provisions are meant to deal with problems that may or may not arise at some point in the future. You may find it easiest to work backwards, in other words consider the various problems that may arise and then fashion solutions to deal with them.

While the following is not an exhaustive list of provisions to include in a shareholder’s agreement, it provides a good starting point.

Directors & Officers
– How many directors will there be and how will they be elected?
– How will vacancies on the board of directors be filled?
– Will the directors be compensated and how?
– Who and how will the officers be appointed? What about compensation?
– What compensation should the shareholder/employees receive?
– What provisions be made for death, disability or retirement of shareholders?

Shares & Dividends
How will security be issued, redeemed and repurchased?
– When will dividends be declared?
– Will there be an absolute prohibition on share transfers outside the original group?
– How can shares be transferred to people outside the original shareholders group?
– When will a mandatory transfer of shares, within the shareholders group, take place?
– How will an optional transfer of shares, within the shareholders group, take place?
– Can shareholders be obliged to sell their shares within piggy back situations or situations of first rights of refusal?

Management & Control

– How will business decisions, during the ordinary course of business, be made?
– What about business decisions, outside the ordinary course of business?
– How will shareholder dead locks be resolved?
– How will disputes be resolved?
– How will the relationship be terminated? What sort of divorce provisions will be included?, e.g. a shotgun provision or a right to invoke dissolution proceedings.

Financial Matters
– How will you ensure the business’s future requirements for capital?
– What circumstances will require additional capital?
– How will the capital be raised?
– If capital is to be raised through shareholder contributions, how much will each contribute?
– What happens if one of the shareholders does not contribute?
– Can the corporation incur debts in excess of specified limits or out of the ordinary course of business over the objections of some of the shareholders?
– What will be the fiscal year?
– Who will the accountants/auditors be?
– Who will have cheque signing authority?

– What should be included in the non-competition clause in the event one or more of the shareholders leaves the business?

– Do you want to include a provision specifying that shareholders provide the others with notice of any proceeding regarding the division of net family property in Ontario, either by the shareholder or the shareholder’s spouse?

– Do you want to include a provision indicating that a spouse involved in a division of net family property will endeavour to cause his or her spouse to keep all business information confidential?

– Should the shareholders be required to enter a marriage contract whereby the non-shareholder spouse would agree not to satisfy an equalization of net family property from the corporation and/or keep all business information confidential?

If you would like further information about this or any other business matter, contact Howard Steinberg or Stanley Landau.