Your business is finally moving. You and your partners incorporated your company, the website is live and your first customers are rolling in. You’re worrying about inbound and outbound marketing, loans, hiring employees, and most importantly, growth. Everything feels great and you’re running on adrenaline.
The next thing you should do? Very few people would answer, “sign a shareholders agreement.” But this is exactly what your next step should be. Why? Read below to learn more.
First, what is a shareholders agreement? A shareholders agreement is an agreement between the owners of a company. It sets the rules of your company and the expectations of each owner, including the management of the company, restrictions on the selling of shares, and the process for resolving disputes.
So, why does your startup or small business need a shareholders agreement? Here are four good reasons.
1) It’s a roadmap for when disagreements arise
Insurmountable disagreements between owners occur more frequently than you think. Some estimate 62% of startups fail due to shareholder conflict. No matter the actual percentage, conflicts and disagreements are inevitable in a small business and you need to decide how these issues will be resolved productively.
One way to ensure there is a fair and transparent way of dealing with conflict is a carefully drafted shareholders agreement. It provides a road map for when disagreements arise, giving answers to questions like:
- What happens if one shareholder wants out?
- Can one shareholder buyout another?
The best time to set a road map for how to deal with disputes is at the earliest possible time — when your team is on the same page.
One of the most common (and important) dispute resolution mechanisms found in a shareholders agreement is a buy-sell provision, also called a “shotgun clause”. It is a simple and common mechanism that resolves deadlocks and allows shareholders to go back to focusing on their company. The most common and unfortunate alternatives if no buy-sell provision exists are the dissolution of the company or litigation.
2) Unanimous Approval on Important Issues
It is common for owners of a small business to hold different share percentages. The result is that the majority shareholders are able to force issues and make decisions for the business that are not necessarily in the minority shareholders’ interests.
To avoid anyone abusing their power in a company, a shareholders agreement can put everyone on equal footing by giving minority shareholders a voice on important issues.
This is why shareholders agreements often identify specific items that require unanimous shareholder approval. Common topics requiring unanimous approval include: entering into loan agreements, election of directors and cash contributions from shareholders.
3) Share Transfer Restrictions
Companies start small for a reason. Small businesses need to gauge their growth and react strategically. But starting small means that the removal or addition of any team member can have a huge impact on the entire organization.
Without a specific provision in a shareholders agreement or articles of incorporation, the law allows for you, as a shareholder, to transfer your shares freely to anybody you choose.
This can be an unwelcome surprise for the other early-shareholders, so shareholders agreements often impose restrictions on the transfer of shares. Restrictions usually require all shareholders to agree before your can sell your shares. Or, at a minimum, other shareholders get the first opportunity to buy your shares when you depart.
The best thing about shareholders agreement is they can be crafted to fit each business’s specific needs. They’re flexible, just like your business.
For example, shareholders agreements can include many other provisions, including shareholder financing provisions, share vesting provisions, non-compete clauses for departing shareholders, mechanisms to value the business and provisions dealing with dividends.
The other benefit of shareholders agreements is that the process of discussing shareholder issues is beneficial to your team. These discussions will force your team to have an open and honest dialogue. Your team will come out feeling stronger and on the same path, knowing that if a conflict arises the hard work has already been completed.
Remember, an ounce of prevention is worth a pound of cure. Spending time and a minimal amount of money on a well thought-out and carefully drafted shareholders agreement will allow you and your team to focus on what you do best: growing your company.
Derek Hopfner is a lawyer and the co-founder of Law Scout (www.lawscout.ca).
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