The Need to Knows of Shareholder Agreements
As a founder, you probably have hired or will soon hire an attorney to help create the legal structure of your company. If you are not planning on hiring an attorney to help with this stage, then please reconsider as they, along with an accountant, provide the crucial groundwork to ensure your vision for the company becomes a reality. One of the main pieces of groundwork they will suggest is that you have them create is a Shareholder Agreement, also known as a “buy-sell agreement” or “buyout agreement.” It is not legally required, but this document certainly should be created for the reasons mentioned in this article. This article is not legal advice and should not be relied on as such, but instead, this article will help you go into the conversation with your attorney more prepared to discuss creating a shareholder agreement.
Second, only to the articles filed with the Secretary of State to give your business legal force, the shareholder agreement is one of the most important documents for your business. So, what is it? A shareholder agreement is a legal binding contract that governs how shares of the company will be redistributed upon the occurrence of certain events. Put simply, it controls what happens to the ownership of the company when crap hits the fan, which it certainly will no matter who you and your co-founders are.
They are meant to safeguard against instability by providing an agreed-upon plan when a shareholder wants or has to part ways with their shares. Generally, the events that trigger the shareholder agreement include a partner leaving the company, a new partner is invited to join, a partner dies, divorces, or becomes disabled, or the company decides to liquidate. Planning for these events ensures that business stays business and does not become personal. It can never be underestimated what kind of emotions will arise during these events and planning on figuring it out when those emotions are running can destroy businesses, friendships, and families.
Beyond ensuring that there is a plan in place for handling big life events of the business, shareholder agreements offer many more benefits. The shareholder agreement can create a market for the sale and purchase of the shares by defining how one can buy or sell shares. It can also establish how the company will fund purchases of shares back from the shareholders, whether it will require further capital contributions from partners or will seek loans. The importance of establishing these processes cannot be understated as it can prevent accidental loss of control of the company. It can prevent shareholders from selling without first getting approval from a majority of the members or it can provide that the company and then the shareholders have rights of first refusal to buy any shares that are being offered for sale. It can also prevent shareholders from having their interests be diluted by having other partners contribute capital to strengthen their positions.
Shareholder agreements can also provide the process by which the company will be valued in the event of a sale or other disposition of ownership interests. Establishing which method or process of business valuations will be used can save future costs of litigation as no two valuations will be the same when employed by owners looking to sell their shares. With a plethora of different methods and a wide array of estimated values stemming from those methods, having a single set method ensures both parties are getting the best price for their purchase or sale of interests.
Finally, the last main benefit shareholder agreements provide is an opportunity for the co-founders and shareholders to discuss these issues amongst themselves before the agreement is in place. By simply having these conversations and implementing an agreement, friends and families can remain friends and families when business situations make it hard to do so. It allows all involved parties to at least understand why things are the way that they are and know that it is not personal.
Proper preparation prevents poor performance. The shareholder agreement is arguably the most important bit of proper preparation a founder can do in this life of his or her business. It is worth the extra up-front capital it will take as it can save millions down the line. The benefits far outweigh the costs, and your lawyer should be there to guide you along the way.