Your Guide to A Shareholders Agreement | Fauri Law
Have you considered how decisions will be made in your corporation? How will your corporation be funded? Who has the power to issue shares or raise capital? Who appoints the directors? A shareholders agreement will address all of these important matters.
What is a Shareholders Agreement
Every corporation is governed by its domestic corporate statute, articles of incorporation and by-laws. These materials typically cover basic corporate mechanics, procedures and rights. However, shareholders often want to agree to matters beyond the scope of the corporate statute and these constating documents. Shareholder agreements cover those matters.
Once you have decided that you and your other shareholder/s in the corporation need an agreement to help govern its affairs, you need to decide what form of Shareholder Agreement will be most suitable. There are basically two options: A standard Shareholder Agreement and a Unanimous Shareholders Agreement (“USA”). A USA is the most common form of shareholder agreement. A USA goes beyond a private agreement and may override certain opt-out provisions of the governing corporate statute and the corporation’s articles and by-laws.
Unanimous Shareholder Agreements (USA)
Under the Ontario Business Corporations Act (the “OBCA”) and Canada Business Corporations Act (the “CBCA”), the management of the business and affairs of a corporation is reserved to its directors, who cannot at common law be relieved by an agreement from their duties to manage the corporation, subject to the provisions that permit unanimous shareholder agreements to restrict the powers of directors and transfer such powers to the shareholders, along with the associated liabilities (CBCA s. 146(1); OBCA s. 108(2).)
A USA can set out which specific powers are to be transferred to shareholders, for example:
- by requiring a greater number of votes of directors or shareholders than that required by the Act to effect any action (CBCA s.6(3));
- by limiting the directors’ discretion to, among other things:
- issue shares (CBCA s. 25(1));
- make, amend or repeal by-laws (CBCA s. 103(1));
- appoint officers (CBCA s. 121(a));
- fix the remuneration of directors, officers and employees (CBCA s.125); or
- borrow money, give guarantees or grant security interests in the corporation’s property (CBCA s.189(1)).
If the USA restricts the discretion or powers of the directors to manage the business and affairs of the corporation, the corporate law statute applicable to the corporation may provide that the directors are released from their duties and liabilities relating to such restricted powers, and those duties and liabilities are assumed by the shareholders, thereby releasing the directors of such personal liability.
One of the key matters addressed by shareholder agreements is how the corporation’s affairs are to be conducted. Where the corporation has a few significant or dominant shareholders, they will likely want the right to nominate a majority (if not all) of the board. However, it may still be possible for the minority shareholders to negotiate board representation and to require some fundamental issues to be subject to a “super majority” approval (for instance, some fundamental issues may require the approval of all majority shareholders and 50% of all minority shareholders).
Except in the case of a USA where the board is stripped of its powers, the influence of shareholders over day-to-day issues which are not subject to shareholder approval will generally be manifested through the appointment of nominees to the board of directors.
However, in closely held corporations, the shareholders may have direct control over the day-to-day management. A shareholder will ideally control important decisions within any management structure. A super majority or unanimous vote may be desired for specific corporate matters.
The list could include any of the following:
- amending or restating the articles or by-laws of the Corporation;
- the declaration or payment of any dividend
- appointment or removal of directors;
- the purchase, redemption, acquisition or any other transfer of shares;
- the issuance of any new shares
- creating any debts, liabilities or other obligations of the Corporation
- a sale of all or substantially all of the assets of the Corporation.
- decision to require additional capital contributions;
- entry into other areas of business.
A fairly common method of funding a business is to require a capital contribution from the partners, founders, or other owners. The amount and value of capital or assets contributed should be clearly stated. If it is expected that additional capital will be needed to fund the venture’s activities, the process for capital calls and payments of extra capital must be spelled out in the agreement. For more information about capital contribution, read our article: What Happens When a Business Needs Money?
Transfer of Shares
Under National Instrument 45-106 Prospectus Exemptions (NI 45-106) and the similar prospectus exemption in Ontario under section 73.4(2) of the Ontario Securities Act, R.S.O. 1990, c. s. 5 (OSA), a private issuer is required to restrict the transfer of its shares either in its constating documents or in one or more agreements with its security holders (section 2.4(1), NI 45-106). Most shareholder agreements include provisions preventing the shareholders from transferring or disposing of their equity interests other than in accordance with the agreement.
One of the major restrictions on share transfer is a pre-emptive right. A shareholder may request pre-emptive rights in the event the entity desires to issue new shares. The agreement will typically give a right of first refusal to existing shareholders in the event of a proposed sale and may include drag-along rights at the request of a major shareholder or tag-along rights at the request of minority shareholder(s). In many cases, there is also a prohibition against transferring shares to a competitor company and selling unvested shares.
For more information on share transfer restrictions, see FAQ discussion regarding pre-emptive rights, rights of first offer, first refusal, piggybacks and drag-alongs.
The importance of the shareholders agreement goes beyond corporate organizational matters, and can determine the future success of your business and any potential exit. The point here is that most exits are mergers and acquisitions (M&A), and most of them happen earlier than you would probably expect from a strategic buyer. Therefore, from day one you need to be ready in case an exit opportunity arises.
There are points during the M&A process where you need shareholder approval. You may well need the owners of the business to agree to sell it. Absent some kind of agreement among the shareholders in advance of what that process is, and on how many people are required to approve the sale, the corporate statutes gave a lot of authority to individual shareholders to potentially block a deal. Therefore, it is very common in the growth company space to have a shareholder agreement in place that makes it easier for owners to come together and agree on terms of an exit.
The following are commonly used provisions in a shareholder agreement that will often provide for multiple means for shareholders to exit (or be required to exit) the corporation:
- Sale to a Third Party Subject to Rights of Other Shareholders. See FAQ discussion regarding rights of first offer, first refusal, piggybacks and drag-alongs.
- Put or Call Options.
- Shotgun Clause.
A shareholder agreement should include mechanisms for resolving disputes; the appropriateness of any particular mechanism will depend on the nature of the disagreement. In addition to mediation, arbitration, or other dispute resolution mechanisms, Shotgun Buy/Sell provisions are useful options to resolve disputes without disrupting the business. One party can make an offer to buy the entire business, and the other party receiving the offer may then elect to be a buyer or a seller on the terms offered. This clause usually benefits the party with the deepest pockets. A well-drafted agreement can significantly reduce the likelihood and cost of litigation in the event of a disagreement.