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What is a Shareholders’ Agreement – and Why You Need One If You’re Starting a New Company

What is a Shareholders’ Agreement - and Why You Need One If You’re Starting a New Company

Toronto business and franchise lawyer, Sukhi Hansra, of Hansra Law, explains how a shareholders agreement helps with everything from developing strong corporate governance to ensuring the smooth day-to-day running of business operations.

While there is no obligation under Canadian law for companies to enter shareholders’ agreements, most do as it safeguards the future of their businesses. When companies scale, their day-to-day and financial operations become more complex and unforeseen issues may arise, which is why good corporate governance ensures contractual agreements are set in place from the start.

It’s all too easy for a company’s financial success to be hindered by death, divorce, disability, disputes and divestiture – all of which a shareholders’ agreement can prevent from happening.

A shareholders’ agreement is the best way to reduce business disputes between owners. It clarifies how decisions will be made and provides a framework for dispute resolution, which is especially important when it comes to handling and making decisions that may affect the success and ultimately the value of the company.

What Is A Shareholder?

A shareholder is an individual, corporation, mutual fund or trust who owns shares or stocks in a corporation. Shares are representations of ownership. A shareholder’s influence on the business is determined by how many shares they own.

Shareholders may have the right to vote on certain matters which pertain to the company and they may be elected to a seat on the board of directors.

What Is A Shareholders' Agreement?

A shareholders’ agreement is a vital contract between a corporation and its shareholders that outlines what activities each entity may or may not do. It establishes the rights of the shareholders and the extent of the duties and powers of the board of directors and management. Typically, a company is run by a board of directors but if those directors are not shareholders themselves, then the latter may feel they should be included in key decision-making processes.

Moreover, a shareholders’ agreement also stipulates how a company’s procedural tasks will be run, ensuring smooth business operations. For example, this may include:

  • who and how board meetings are called
  • quorum thresholds
  • when to submit budgets
  • how shareholders should approach business opportunities
  • what the restrictions are in selling shares
  • what action should be taken if the company needs further funding

When Do You Need a Shareholders' Agreement?

  1. You should have a shareholders’ agreement the moment your company has more than one person with equity – more than one owner. When you have another stakeholder in the business, it’s imperative to lay out the terms and conditions that will govern the relationship between you, them and your business.
  2. Capital might not be the only contribution shareholder’s make and so it’s important to have clear terms on matters of ‘sweat equity’ i.e., how the mental and physical efforts of shareholders will be measured and equated to equity.
  3. You may have silent or passive investors and want to define the limits and/or terms and conditions of their ownership to prevent them from having a monopoly on your business.
  4. If you have foreign investors, you may need to limit their degree of ownership to avoid unfavourable corporate tax that may be detrimental to your company. 

They Safeguard Shareholders’ Interests

Shareholders’ agreements protect every shareholder’s investments and ensure the rights and protections application to each shareholder. They prevent situations where changes in a single shareholder’s circumstances may affect the company.

For example, in the event of a death, the agreement will ensure the financial interest of the company and that of the shareholder’s family is upheld or if a shareholder walks away from a company, a non-competitive clause ensures they don’t poach clients.

A shareholders’ agreement also protects the rights of minority shareholders and their investment value. It guarantees the majority of shareholders can’t muscle the minority into making certain decisions that go against their interests. In most cases, “voting pool” agreements allow minority shareholders to agree with one another on ”block voting” whereby they pool their shares and vote collectively to strengthen their position.

They Protect Your Company by Restricting the Ownership of Shares

As a new company, you might want your initial shareholders to retain shares rather than allowing external investors to buy the majority. In this case, a shareholders’ agreement can help restrict who may and may not acquire shares, as well as what percentage they are entitled to.

They Help with Financing

A shareholders’ agreement also stipulates how the company will access funds and whether or not shareholders should contribute towards raising capital. Lastly, having a shareholders’ agreement places a company in good stead as it demonstrates the stability of a business to banks and creditors whom you may need to approach for financing. 

Conclusion

All shareholders’ agreements contain operational management, rights and obligations, protection and exit clauses. The content of your agreement will depend on the type of company you have and at what stage of development it is. Most importantly, a shareholders’ agreement provides you with peace of mind, ensuring you are legally equipped to handle any business challenges that may come your way. 

If you’re considering the benefits of creating a shareholders’ agreement for your company, a good first step would be to speak with an Accountant or Business Lawyer who can explain the benefits and limitations. 

Learn More:

Toronto Business and Technology Lawyer

Hansra Law creates innovative solutions for our clients that adapt to our clients’ growth, no matter the size or stage of their business. To protect the future of your business, contact Sukhi Hansra to schedule a free consultation  at (416) 580-0345.

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