The Smart Way to Prepare a Shareholder Agreement
1. Fill Out the Online Form
In order to reduce your legal spend its essential to negotiate as many terms of your shareholder agreement upfront; before you get Wires Law involved. Filling out the online form forces founders to negotiate their shareholder agreement with their partners setting them well on their way to getting a deal done.
2. Get a Fixed Fee Quote
Once you’ve filled out the online form Wires Law can provide you with a fixed fee quote to prepare your shareholders’ agreement. To accept the quote and move forward clients sign a retainer to permit Wires Law to act on behalf of your company.
3. You’re in Business
Once the retainer is signed Wires Law will get to work and start drafting. When complete, we provide you with access to your online Connect Account to access your shareholders’ agreement for execution. Wires Law also works with clients to ensure the document is executed properly and the corporate minute books are in order.
Start-ups who paper a shareholder agreement and agree on how to manage these issues upfront are the ones best prepared to stage-off future disputes, and as a result, best positioned to succeed.
Shareholder Agreement FAQ’s
SHAREHOLDER AGREEMENTS: WHAT ARE THEY?
An agreement between some of all of the shareholders of a corporation. There is an important distinction between an ordinary shareholder agreement and unanimous shareholder agreement.
SHAREHOLDER AGREEMENTS: WHY HAVE ONE?
- Cover-off certain events like the death, bankruptcy, divorce, conviction, disability or departure of a shareholder. Many co-founders do not want their partner’s estate, spouse, creditors or trustees to step into their partner’s shoes. Shareholder agreement often include provisions permitting the corporation to buy back a shareholder’s shares if they are about to be transferred to a third party as a result of one of the above trigger events.
- Define a process for valuing the corporation’s shares. A valuation clause allows the shareholders to either mutually agree on a fair market value for the shares or where the parties cannot agree, the matter can be referred to a chartered business valuation expert.
- Protect company confidential information and restrict other shareholders from competing with the corporation or soliciting its customers and key employees away from the business. Although the law become tricky on the enforceability of such restrictive covenants, where the provisions are drafted within the confines of what’s “reasonable” restrictive covenants can be an effective way to protect the company’s value and goodwill.
- Delineate control of the corporation. Shareholder agreements can be used to manage who controls the corporation and give rights to shareholders they otherwise would not have. For example a shareholders’ agreement can place restrictions on the directors and management. Common areas for restrictions include restrictions on:
- Issuing further shares or options in the corporation;
- The redemption or purchase for cancellation of any outstanding shares by the corporation;
- The conversion of any existing shares to a new class;
- Approving any capital expenditure or leasing of equipment of more than a certain amount.
- The granting of any loans to or from a shareholder;
- The declaration or payment of dividends;
- Any payment or increase in bonus, wages or salary to any of the officers, employees, or directors;
- Any proposed sale, lease, exchange or other disposition of property or assets of the corporation other than in the ordinary course of business;
- Any change in the number of directors on the board;
- Changing of the corporation’s accountant;
- Hiring and firing of employees of the Corporation;
- Minimize disputes between shareholders and co-founders. While shareholder agreements do not guarantee you will not have a dispute with another shareholder or founder, it can provide a framework for managing disputes. Shareholders often elect to include an arbitration clause in order to keep disputes out of court and out of the public’s eye.
Most shareholder agreements also take preventative measures on issues that commonly lead to disputes. For example, a shareholders’ agreement can include provisions on how funds will be raised in the future, how and when shares can be transferred, who gets to appoint board members and how shareholder and director meetings are held etc.
The Shotgun Clause
One extreme remedy for dispute resolution is the shotgun clause. A shotgun clause permits any shareholder to offer to purchase the other shareholder’s shares. If the offer to purchase is declined, the other shareholder must purchase the offeror’s shares. It is an extreme remedy for owner disputes and the clause can be abused and unfair when:
- Unequal financial resources.Shotgun clauses are not always fair in practice if the shareholders have significantly different financial resources. The shareholder with the most money can put an offer together that the responding shareholder cannot match financially, making the choice to buy or sell less meaningful.
- Unequal ability to finance the company. The same is true when it comes to financing the company post-closing. Through experience, reputation, track record or hard assets, some owner-managers are better able to finance their business post-closing than others. If one shareholder is at a significant disadvantage in that department, being a buyer just might not be something that they can pull off.
- Unequal ability to operate the company. A shotgun clause may also be unfair if all shareholders do not have an equal ability or opportunity to operate the company. If one shareholder is a passive investor, or lacks the skill or ability to operate the company, putting them in a position where they have to choose to sell or buy may not be as “fair” in reality as it looks in theory as buying may not be a realistic option to them.
- Unequal desire to own and operate the company. Also, in many cases, the shareholders do not have an equal desire to own and operate the company on their own. For example, if the shareholder receiving the shotgun is seventy and retired, or in ill health, or wants to do something else with their life or money, being a buyer may be unrealistic if not downright impossible.
- Unequal desire to give up ownership of the company. The reverse can also be true. Since the shotgun clause requires even the initiating shareholder to be willing to be a seller, it requires both shareholders to be willing to give up ownership. This can be very difficult in some situations. For example, one shareholder could be a founding shareholder with their name on the door, or a third generation owner with strong emotional attachments to the business. A shotgun buy-sell mechanism may not be fair in this situation.
- Equivalent shareholdings by class and number. A shotgun clause also assumes that each shareholder has the same type and class of share. This is not always the case. Different shares have different attributes. For example, equity ownership may be shared 50/50, but voting control could be 51/49. Valuing the voting shares and dealing with the potential premium for control can make the different positions between the shareholders less than “equal”.
- Equivalent investment in shareholder loans, options, warrants, etc. The same is true for shareholder loan accounts, options, warrants and other security or investment in the company. They all must be dealt with as part of the separation process. Unless they are roughly equivalent, this can be more of a burden or risk to one shareholder than the other.
- Equal impact on change in personal employment. The personal impact of leaving the company can be significantly different for some shareholders than others. Depending on the age or personal circumstances of the shareholders, being a seller and losing their job may be more severe for one shareholder than the other.
- Reasonable impact in terms of restrictive covenants. Shareholder agreements usually include non-solicitation, non-competition and similar covenants. These covenants could severely restrict or damage the career or financial circumstances of the departing shareholder, especially in circumstances that amount to a “force-out”.
- Unequal access to information. For a shotgun clause to work, each shareholder must have equal access to information about the company so they can know whether to make an offer, or respond by being a buyer or a seller. Access to information will also be critical in naming or assessing the price and payment terms, and arranging financing.
- Unequal support from other stakeholders. Finally, no company succeeds without support from a number of third parties, including senior management, employees, customers, suppliers and financiers. Unless all shareholders have equal support from key stakeholders, the opportunity to buy may not be realistic for everyone.
HOW DO SHAREHOLDER AGREEMENTS PROTECT FROM FOUNDERS LEAVING THE COMPANY WITH SHARES THEY DIDN’T EARN?
There are two main ways (1) issuing options instead of actual shares; or (2) agreeing to a reverse vesting scheme. When a co-founder has not made a significant capital contribution to the company but has been issued a sizable portion of the shares, it would unfair for him or her to leave the business and expect to maintain their share ownership.
This is why reverse vesting schemes are quite popular for startups. Reverse vesting rights permit the corporation to buy back a portion of a shareholder’s shares, at a nominal value, if they decide to leave the company before a pre-defined date.
This protects against the scenario where one of the shareholders quits and the other continues to operate the company for the “quitting shareholder’s” benefit. Founders do not want to find themselves in the situation where one shareholder is doing no work, has left the company but enjoys the profits of the company as if he remained an owner.
Usually reverse vesting in done on a sliding scale. For example, if a shareholder leaves the company within the first year, the corporation can buy back all or 90% of their shares. If they leave within the first two years, the corporation can buy back, say 30% of their shares and so on. This encourages founders to stay when the going gets tough.
Stock Option Plan
Drip-feeding founders equity in a stock option plan achieves the same objects of a reverse vesting sheme, requiring the founders to earn their shares as they go. Shareholder agreements can also set out a framework for issuing stock option to key employees or contractors. Usually startups restrict their option pool to 10% of the issued and outstanding shares.
HOW LONG IS A SHAREHOLDERS’ AGREEMENT GOOD FOR?
As new shareholders join the company, for example early stage investors, they will want to become part of the agreement and they will most likely add additional complexity. Often, once a first round of private investors join the company they want to renegotiate provisions in the shareholders agreement. For example, they may want to impose further control provisions (restrictions on the power to manage), anti-dilution rights, pre-emptive rights and tag-along rights) and other provisions to facilitate an exit.
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