Fact checked for accuracy by Billie Anne Grigg, a bookkeeper and Mastery Level Certified Profit First Professional.
Isn’t it amazing how many items you need to learn about after forming your company?
You need to figure out the operating agreement, corporate bylaws, and the shareholders’ agreement, among other documents.
While your company’s corporate bylaws are mandatory, the shareholders’ agreement is an optional document, but can present dangers if you run a company without one.
Inside the shareholders’ agreement, you’ll put all the obligations and rights of shareholders on paper. This agreement is also referred to as the stockholder’s agreement.
In this article, you’ll learn everything you need to know about a shareholders’ agreement and what to include in the version you draft for your business.
What is a Shareholders’ Agreement?
A shareholders’ agreement is a document that the shareholders write up as the agreement between the corporation and themselves. The main goal you’re looking to accomplish is to define the privileges and rights of the shareholders.
The document also includes information about the management of the business. While the Articles of Incorporation define the company’s key players, the shareholders’ agreement expands into the roles and responsibilities of the initial shareholders.
Keep in mind that you might need to amend the shareholders’ agreement in the future after additional shareholders enter the picture.
Think Through This Process Seriously
You should understand that anything included in the shareholders’ agreement has a direct impact on how your company will make future decisions.
Even though a management team and board of directors may exist already, all company parties must operate under the guidelines laid out inside the shareholders’ agreement.
What Does a Shareholders’ Agreement Include?
The same strategies will work whether you’re starting a small company or have a big group of investors about to invest in the business.
Take the time to have as many meetings as necessary to figure out the shareholders’ agreement details. Part of this process should entail deciding whether you’ll eventually take the company public or keep it within a smaller circle of shareholders.
Let’s review what to include in the shareholders’ agreement.
Describe the Parties Involved
You need to name all the initial shareholders properly because you’re creating a legally binding contract with the shareholders’ agreement. List each shareholder’s legal name, address, and phone number.
Identify who should become the managing shareholder and the names of all company officers. Specify that the shareholders represent one party and the corporation acts as the other party.
List Shareholder Responsibilities
Use specific language when describing the responsibilities of shareholders or officers and the actions they’re permitted to take as company representatives.
One of the purposes of the document is to keep the company running well while avoiding shareholder arguments and disputes. You can establish rules for appointing and terminating board officers and directors.
Use specific language in this area so that you can use the shareholders’ agreement to settle all future disagreements or problems.
Establish Shareholder Voting Rights
Typically, the board of directors and shareholders are the same people when starting a small company. Over time, you’ll find that a more diverse group of people make company decisions as the business grows larger.
Use this section of the agreement to set forth shareholder voting rights. Establish which type of vote to use when making decisions.
You might list some decisions as majority vote situations. You could also state that more important decisions must meet a certain percentage of the majority vote, such as 75% of all shareholders. It’s even possible to establish the board of directors as the only voting party for certain decisions.
What Are Some Potential Company Decisions to Think Through?
Avoid any tendencies to rush through the process of detailing all of the potential decisions the company may face in the future. Rushing through when creating the shareholders’ agreement could put you into a disadvantageous situation down the road.
This is the chance for all people involved to think about how to avoid future problems or conflicts. Here are some decisions that your company might face in the future:
- Taking out loans
- Paying back loans
- Declaring dividends
- Buying real property
- Entering into bankruptcy
- Leasing office space
- Dissolving the company
- Changing the type of business
- Changing the company’s name
Regulations Regarding Stock
Some businesses grow to the point where stocks need to get sold or transferred to other shareholders. Include language in the shareholders’ agreement that protects the interests of the initial shareholders when it comes to transferring or selling stock.
You might want to list what kinds of transfers or sales your company allows. Or, you can insert language to restrict specific types of sales or transfers. Using restrictions regarding who can buy or inherit company shares protects you and other shareholders.
Without these provisions in the shareholder’s agreement, it’s possible for outside individuals, corporations, or LLCs to buy shares and cause big problems for you.
Is your company a family business, for instance? If so, then you probably have dreams of keeping it in the family for generations. You want to prevent situations where outsiders can purchase stock and potentially take the business out of your family’s control.
Future Stock Situations to Consider
What happens if a shareholder gets divorced or passes away? You can create restrictions where shares get transferred only to a certain family member or the company buys back the shares from the dead shareholder’s estate.
What will you do if a shareholder wants to sell stock to an outside party? You might use a provision that states a process for allowing current shareholders to buy those shares instead.
Outline Financial Responsibilities of Shareholders
It’s exciting to start a business. Everyone typically works hard to lift the company off the ground. Unfortunately, this doesn’t always play out on a long-term basis.
Include details for how much each shareholder must invest initially into the business. Make sure each shareholder has “skin in the game” to avoid the temptation to slack off on duties in the future.
Legal Obligations
It’s probably impossible to avoid 100% of all future disputes among shareholders. However, if you lay out the legal responsibilities of each shareholder at the beginning, then it’s possible to remain civil when resolving disagreements months or years later.
Write out all legal obligations for each individual who signs the shareholders’ agreement. This lays down the company’s foundational structure for how to remain “on point” as all shareholders work toward business growth.
Distribution of Dividends
How will you pay dividends to shareholders? Every shareholder will want to understand how they’ll start getting paid back after putting in their initial investment. You can decide to distribute dividends:
- Quarterly
- Every six months
- Annually
Meetings and Information
Include the date and time of annual meetings. State the fact that all shareholders will have access to quarterly and annual reports.
Governing State Law
Like any other contract, your company’s shareholders’ agreement is subject to its state’s laws. Include language that makes it clear that the business will remain governed by the state it conducts business in.
Effect of Noncompliance
List how the corporation will remove any shareholder who doesn’t work within the restrictions of the agreement.
Arbitration
You might want to include language that states how all parties agree to settle disputes by arbitration while waiving the right to a jury trial.
Exit Strategy Language
Your shareholders’ agreement must state what will happen if all parties agree to dissolve the company. List how shareholders get their investment money back. As well, you should discuss how one shareholder can exit without financially harming the remaining shareholders.
Example of a Shareholders’ Agreement
A shareholders’ agreement is a long document. For that reason, we’ll link you to several sources where you can view different types of these documents or build your own.
This shareholders’ agreement example details a 2003 document for Eastchester Enterprises, Inc in Florida. Take note of Article IV where you get to see how the shareholders listed the share percentages.
Here’s a sample agreement for Carpe Diem Technology Corp.
Some companies provide free shareholders’ agreement templates that you can use for your business. Here are three to look into:
Does Your Business Need a Shareholders’ Agreement?
Legally speaking, there isn’t any requirement for a business to write out its shareholders’ agreement. However, that doesn’t mean you should forgo putting one into place. It’s in the best interest of the company and all shareholders to agree on everything listed inside this type of document.
You’ll inevitably end up facing future regret that the business didn’t list all requirements for dealing with situations such as:
- Handling disputes fairly and without animosity
- Paying dividends
- Making basis company decisions without arguments
- Potentially losing control of the company after outsiders buy shares
- Adding new shareholders
- Handling divorces, bankruptcies, or deaths of shareholders
Don’t allow those situations to create bad blood between you and the other key players of your company. Put a shareholders’ agreement in place immediately.
How Do You Set up a Shareholders’ Agreement?
It’s not advisable to set up the shareholders’ agreement without the help of a business attorney. Remember, you’re signing a legally binding contract when signing off on the shareholders’ agreement. You want to make sure that all legal considerations help to protect the interests of the company and all shareholders.
Your goal is to grow the business. As it grows, you’ll encounter many changes. Conflicts may arise between shareholders. Putting this contract together can help you avoid costly legal battles in the future.
A lawyer possesses the knowledge that helps you and other shareholders understand the rights and responsibilities of everyone involved. He or she can also help you think about all potential situations you need to include in the shareholders’ agreement.
Shareholders’ Agreement vs. Corporate Bylaws
Don’t confuse the corporate bylaws with the shareholders’ agreement. They’re completely different documents.
The corporate bylaws list rules around the board of directors and committees, as well as day-to-day operations. The shareholders’ agreement addresses other issues such as legal obligations, equity shares, financial responsibilities, distribution of dividends, exit strategies, taking out loans, business bankruptcies, and how to handle shareholder deaths or divorces.
The Last Word
You don’t technically need a shareholders’ agreement. But you’ve also learned that running a business without one isn’t the best way to operate your company. Your next step is to enlist the help of a business contract lawyer and ask them to draft the shareholders’ agreement for you and the other shareholders.
If you take the time now to list everything that a shareholders’ agreement requires, then you’ll save yourself potential problems that come into play without this type of contract in place.
Filed under: Advice Columns
