"Shareholder Agreements" - The essentials

When a company is first created, its founding shareholders determine how a company will be owned and managed. This is when a "shareholders agreement" kicks in. The shareholders agreement may be amended when new shareholders enter the picture for various reasons, i.e. new shareholders may want to add new terms before they become part of the team. Not having such an agreement can lead to serious legal ramification, and future disputes arising amongst shareholders may create irreconcilable harm to the overall well-being of a company.

The incorporation of a company must be in compliance with the law that governs the corporations. Companies are incorporated in a particular jurisdiction (e.g. provincial or federal) and must adhere to the applicable legislation, e.g. the Canada Business Corporations Act, or the Ontario Corporations Act. This legislation lays out the ground rules for corporate governance, i.e. what you can and cannot do, who can be a director, can a company issue shares, how can you buy or sell shares, etc. When a company is formed, it files a Memorandum and Articles of Incorporation (depending on jurisdiction) which are public documents filed with the Registrar of Companies. A shareholders agreement, however, is confidential and its contents need not be filed or made public.

When a company is formed, its shareholders may decide on a set of ground rules over and above the basic legislation that will govern their behaviour. For example, how do you handle a shareholder who wants to sell his or her shares? Should it be possible to buy out a shareholder? How are disagreements resolved? Who can sit on the Board? Who has the decision-making authorities? Can a shareholder (the founder of a company) be fired? 

There is no need for a Shareholder Agreement if the company has only one owner. However, if there are more than one owner, it is very crucial to create a Shareholder Agreement. Each company should have its own tailored Shareholder Agreement depending on the mission & vision and business goals of the owners. When a company  becomes a "public" company, such an agreement is no longer needed, and the relevant law and securities regulations will become applicable.

What to include in a Shareholder Agreement?
(This is a non-exhaustive list)

• what is the structure of the company? 
• how equity is divided amongst the shareholders?
• how are the parties to the agreement?
• are there any vesting provisions? for example shares may be subject to cancellation if a shareholder/manager quits)
• are shareholders allowed to pledge their shares?
• who is on the Board? 
• who are the officers and managers?
• what constitutes a quorum for meetings?
• what are the restrictions on new equity issues?
• how are ownership buyouts to be resolved? 
• how are disputes to be resolved among shareholders? (* very important to review the dispute resolution clause(s)with your lawyer?)
• how are share sales done?
• what are a shareholders' obligations and commitment?
• what are shareholders' rights? 
• what happens in the event of death/incapacity?
• how is a share valuation determined 
• what are the operating guidelines or restrictions (budget approvals, spending limits banking, etc)
• what types of decisions require unanimous board and/or unanimous shareholder approval?
• compensation issues - remuneration of officers & directors, dividend policies
• are other agreements required as well, e.g. management contracts, confidentiality agreements, patent rights, etc?
• should there be any restrictions on shareholders with respect to competing interests?
• what could trigger the dissolution of the company?
• what is the liability exposure and is there any corporate indemnification?
• are there any financial obligations by shareholders (bank guarantees, shareholder loans, etc)?

Some Do's & Don'ts:

• don't confuse shareholder issues with management issues
• don't confuse return on capital with return on labour (i.e. cash investment vs founders' time commitment)
• don't get caught up in legalese - decide what you want, then have your lawyer put it in proper form
• do make sure everyone's objectives and visions are compatible 
• do separate the roles of shareholders, directors, and managers
• do talk to others who have gone through this process
• do ask yourself what the downside is - the most practical question is: what's the worst that can happen to you under the agreement?
• do get some tax advice. It is very important that some tax planning be done early to avoid a headache later when you've made millions. e.g. you want to make sure that you are not compensated by being given shares, you want to make sure you own shares early so that you can use the small business lifetime capital gains exemption, maybe a family trust or holding company should own your shares.

MOST IMPORTANTLY: DO HIRE A LAWYER!