You’re in business with other individuals. They may even be members of your family. The company is growing and all of you are working hard. You all agree with the direction in which the business is heading.
Does this sound like your company? But have you given any thought to how you and your fellow shareholders will resolve disputes should they arise? What will happen if one shareholder dies or becomes disabled?
A shareholders’ agreement is a contract between shareholders of an incorporated business that puts mechanisms in place to deal with important issues before they become problems. For business owners who are carrying on business with others in an unincorporated partnership, the issues discussed in this article are dealt with through the use of a partnership agreement. Both agreements are an invaluable tool you can use to help ensure that your business grows and prospers.
Let’s look at an example where a shareholders’ agreement could have helped to prevent a major problem. Two sisters, Jane and Mary, started an incorporated catering business in the mid-1970s. They had always been close. In fact, their families live in the same town and they vacation together. As issues arose, Jane and Mary were able to discuss them and reach a mutually satisfactory agreement. Due to this, the sisters didn’t think it was necessary to anticipate problems and therefore they didn’t consider a shareholders’ agreement.
You might also be thinking that the sisters don’t need a shareholders’ agreement. They have always been able to resolve differences, so what’s the point of spending the money to document their business relationship in writing?
It turns out that there was one issue that they never could agree to deal with—who would take over the business when they couldn’t run it anymore? Although they realized that a solution would eventually have to be found, they believed that they could deal with it later, once they were closer to retirement.
Then two events occurred which turned the lack of a shareholders’ agreement (and a succession plan) into a major issue. First, children of each sister became actively involved in the business. However, no thought was given to how those children would interact with each other once the two sisters were no longer in the picture.
Then Jane (now in her mid-sixties) suffered a heart attack. After a fairly lengthy recovery, she realized that working long hours in the business was not something she wanted anymore. So, she thought the time had come to pass on the business to the next generation. However, Mary was still in good health and didn’t share her sister’s desire to begin the succession process.
What follows in such a situation varies. In the case of the McCain family, the end result was a public conflict in which lawsuits were filed and the matter was eventually settled out of court by a New Brunswick judge who was hired as an arbitrator. For smaller businesses (as is the case for Jane and Mary), the business itself may not survive such an event.
How could a shareholders’ agreement have helped?
A shareholders’ agreement would have provided two benefits. First, an executed agreement would obviously set rules that would be followed to resolve business disputes and events such as Jane’s illness. But more importantly, the process of working through an agreement would help the sisters identify possible business risks and let them discuss in advance how they would resolve each issue if it arose and perhaps even set aside resources in advance (such as life, disability or critical illness insurance).
This could have been accomplished when they were getting along, in good health and in a good position to be objective over who should take over the business. In particular, the agreement could have provided for a couple of options—a mandated succession plan where each sister would pass on their interests to the next generation or a buy-sell agreement which would allow one sister to buy the other’s shares at a time when she became unable to carry on in the business due to poor health. Although the sisters could try to negotiate such an arrangement now, the point really is that their interests have already diverged and the issue is causing disharmony in their relationship. An added problem is that Jane is potentially at a disadvantage in any negotiations as she is unable to continue in the business.
In addition to buy-sell rules on disability or death and rules for succession, a shareholders’ agreement will usually include mechanisms to help shareholders deal with important issues such as:
Major business decisions such as a merger;
Rules for employing family members;
Rules for disposing of major assets or a business line;
Remuneration of shareholders and setting work expectations;
Corporate financing decisions;
Rules for determining a price of a shareholder’s interest and the conditions under which the interest can be transferred (in addition to illness or death);
Liquidation of a shareholder’s interest in the event of disagreement, disability or death (this would include buy-sell agreements for shares); and
Rules for resolving deadlocks (such as arbitration, mediation or appointing additional directors).
This list is not exhaustive—any issue of mutual concern to the shareholders of a company can and should be covered in the agreement.
The moral
You should put mechanisms in place now to help you deal with major issues at a time when you and your fellow shareholders are enjoying a good relationship, good health and can be objective. This is usually accomplished through the use of a shareholders’ agreement for an incorporated business or a partnership agreement for unincorporated partners.
* article published in BDO tax series -
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