Last Updated November 22, 2022
What is a Shareholder Agreement?
A Shareholder Agreement, also called a stockholder agreement, is a legally binding contract between a corporation's shareholders that outlines their rights, responsibilities, and obligations. It also includes information about management and how the company should be operated.
The specific contents of an agreement vary depending on the corporation and its shareholders, but it typically addresses the following:
What is a shareholder?
A shareholder is a part owner of a company. An individual, company, or institution can be a shareholder. They become one by owning at least one share of stock in a company.
If the stock increases in value, the shareholder makes a profit on their investment into a company. However, if the company performs poorly and the stock’s value drops, the shareholder can potentially lose money.
A company's shareholders will usually create a Shareholder Agreement to establish the rules governing the shareholders' relationships with the company and one another.
Why should I create a Shareholder Agreement?
A Shareholder Agreement is valuable for shareholders because it addresses crucial issues that help keep the company running smoothly. If there are future disputes between the shareholders, they can refer to the agreement as a guide for resolving the problem.
It’s recommended that the shareholders create a Shareholder Agreement before business begins. Doing so helps ensure shareholders agree and understand their rights and obligations to the company.
What happens if there’s no Shareholder Agreement?
When a company doesn't have a Shareholder Agreement, it significantly increases the likelihood of conflict between the shareholders. This is because there aren't rules to guide their acts, determine how they'll make decisions as a group, or find resolutions to disputes.
This is especially the case with smaller companies where two shareholders each hold 50% of the shares. If they disagree on how to proceed, it can create a deadlock.
Shareholder Agreements can also regulate the sale of shares, so they aren't sold to a third party before the current shareholders can buy them.
What are shareholder rights?
As part-owners of a company, shareholders have certain rights. These rights typically include the following:
- Appointing or dismissing directors (through a shareholder vote)
- Attending shareholder meetings
- Making important decisions regarding the company
- Receiving dividends
- Receiving reports about the company
- Reviewing company records
- Selling or transferring shares
Shareholder rights also include how shares are treated when a shareholder wishes to exit the company. Some standard clauses that handle how shares are transferred under such circumstances include:
Right of first refusal clause
This clause comes into effect when a shareholder wishes to sell their shares. Right of first refusal means they must first offer to sell their shares to other shareholders at a fair value. If the shareholders can’t purchase them, the selling shareholder can offer them to a third party.
Shotgun clause
A shotgun exit provision, also called a buy-sell agreement, may be used in the event of a shareholder dispute. It specifies that one shareholder can offer to buy another shareholder's shares. The shareholder who was approached with the offer can then either agree to be bought out or buy out the first shareholder's shares at the offered price.
Tag-along clause
A tag-along clause typically applies to majority shareholders who intend to sell a significant portion of their shares. It can also apply to a proposed sale that will result in a third party becoming a majority shareholder. The clause protects minority shareholders because a buyer must purchase their shares at the same price as the shares owned by a majority shareholder (thus agreeing to buy all the shares).
What is a share valuation clause?
A share valuation clause establishes how shareholders determine the value of a company’s shares. Valuation occurs when shareholders want to sell or transfer their shares to another shareholder or after they pass away.
Without establishing a method for share valuation, companies may experience unnecessary uncertainty or disagreement regarding the value of shares.
Share valuation clauses are sometimes called stock valuation clauses.
What's the difference between a Partnership Agreement and a Shareholder Agreement?
Shareholder Agreements and Partnership Agreements are similar but used under different circumstances.
A Partnership Agreement is used between two or more partners in a for-profit business partnership, whereas shareholders in a corporation use a Shareholder Agreement.
Can a Shareholder Agreement override Articles of Incorporation?
No, a Shareholder Agreement does not override a company's Articles of Incorporation. However, the shareholders and directors can amend the Articles to align more accurately with the Shareholder Agreement.
How do I create a Shareholder Agreement?
You can easily create a Shareholder Agreement by completing LawDepot’s questionnaire. Using our template ensures you complete the following necessary steps.
Step 1: Provide details about the corporation
Start your Shareholder Agreement by providing the corporation’s name, address, and state in which it’s located.
Step 2: Include details about the shareholders
Your agreement needs to specify each shareholder's name, address, and whether they're an individual or a corporation.
Step 3: State if the Shareholder Agreement will include warranties
State whether the corporation will provide a list of its current shareholders. Doing so confirms for the shareholders how many shares have been issued and who owns those shares.
If the corporation provides a list of shareholders, specify whether each shareholder will warrant that they are the sole beneficial owner of their shares. When shareholders warrant that they're the beneficial owner of their shares, no other person is interested in them, nor are they held in trust for someone else.
Step 4: Provide details about share ownership
In your agreement, you must also state the class of shares (e.g., Class "A" Voting, Class "B" Non-Voting, etc.) each shareholder owns, as well as how many shares they own.
Step 5: Determine how the corporation’s directors will be appointed
Include how the corporation will appoint its directors. Typically, the shareholders will elect directors or have each shareholder appoint one director.
However, there are many other ways to go about choosing directors. For example, the shareholders may decide that the corporation’s president will select them.
When selecting directors for a corporation, it's essential to have fair representation for both majority and minority shareholders.
It should also be noted that all directors must act in the corporation's best interest, no matter how they were elected.
Alternate directors
In case of a vacancy, you can also appoint alternate directors that will step in. If you wish to do this, include the names of each alternate director in your Shareholder Agreement.
Step 6: Specify the corporation’s officers
A corporation's officers include the President, Vice-President, Treasurer, and Secretary.
Specifying the corporation's officers may prevent subsequent shareholders from firing your officers even if they acquire a majority share or control of the board of directors. This may provide a level of managerial consistency to the company.
However, for the same reason, specifying the officers may also prevent the company from attracting new investors who want to install their own management team to run the corporation.
Step 7: State which decisions are subject to shareholder approval
You can use your Shareholder Agreement to specify which decisions are subject to the shareholders' approval.
The directors will generally make most of the decisions affecting the company's management. However, selecting specific management issues that will be decided by shareholders in the Shareholder Agreement preserves the right of the shareholders to maintain control over issues vital to the corporation.
Some areas that shareholders may want to maintain decision-making control over include:
- Business and finance (e.g., selecting a bank for the corporation)
- Capital and assets (e.g., disposal of assets valued above a certain amount)
- Shares and new share issues (e.g., issuing new shares for non-monetary consideration)
Step 8: Determine the duration of the Shareholder Agreement
Determine when the Shareholder Agreement will take effect and when it will end. The agreement can terminate when all shareholders agree to end it or on a specific date.
Having an end date ensures that the shareholders can cancel the agreement regardless of all the parties agreeing. This is a beneficial arrangement if a demanding shareholder refuses to terminate the agreement despite termination being in the corporation's best interest.
If you choose a specific end date, you can always renew the agreement before it expires. If your agreement doesn't have an end date, you'll typically need a Termination Agreement to cancel it formally.
Step 9: Outline what happens if the corporation needs additional funds
Use your Shareholder Agreement to outline what will happen if the corporation ever needs additional funds. Specify whether the shareholders will buy more shares or provide loans to the corporation.
Also, state who will determine that the corporation needs additional funds. For example, the decision can require the approval of a certain percentage of the shareholders or the board of directors.
Step 10: State whether existing shareholders will have preemptive rights
Preemptive rights give existing shareholders the right to buy any newly issued shares from the corporation before offering them to outside parties. This arrangement protects existing shareholders by allowing them to retain their company ownership percentage.
Some disadvantages of preemptive rights are that they may cause long delays in the sale of shares and that they may discourage sophisticated institutional investors from investing because the third-party investors may get a smaller proportionate share of the corporation than they might want if the preemptive rights are exercised.
Step 11: Specify whether shareholders are prohibited from selling shares
Specify in your agreement whether shareholders are prohibited from selling their shares. This includes the sale or transfer of any interest in the shares.
Step 12: Outline the valuation of shares
If you wish to include a valuation clause, use your agreement to outline who will set the value of the shares.
If you decide that the shareholders will set the value annually, you can also specify the current value of the shares in each class and what happens if the shareholders fail to set a value.
If the shareholders don't set a value, the corporation can pay a professional valuator to set the value of the shares. Having the shareholders place value on the shares may lead to a large over-or-under valuation. Either mistake can be detrimental to the company and all affected shareholders.
Step 13: Decide if the corporation will pay dividends
If the corporation will pay dividends, specify the following:
- What percentage of profits will be paid as dividends
- How often will dividends be distributed (e.g., annually, bi-annually, or quarterly)
- Any additional provisions for dividend distribution
Step 14: Specify what happens if a shareholder dies or becomes incapacitated
Your agreement should specify what happens to a shareholder’s stock in the corporation if they die or become incapacitated. For example, your Shareholder Agreement can give the other shareholders the option to purchase their shares, or it may force the remaining shareholders to purchase their shares.
Step 15: Include non-compete and non-solicitation clauses (if applicable)
Your Shareholder Agreement can include non-compete and non-solicitation clauses that last anywhere from six months to five years.
Non-compete clause
A non-compete clause prohibits shareholders from competing with the corporation while they’re owners in the corporation and for a specific period after they have left the corporation.
In a small corporation, customers deal closely with the shareholder. A non-compete clause prevents an influential shareholder or former shareholder from attracting customers away from the corporation.
A shareholder that leaves the corporation may also have confidential information that they can use to compete against the corporation.
Non-solicitation clause
A non-solicitation clause prevents shareholders or former shareholders from inducing other shareholders, directors, officers, or employees to leave the corporation or to compete against it.
This clause prevents an influential shareholder from stealing key employees.
Step 16: Determine how the shareholders will resolve disputes
Specify whether the shareholders will use any of the following to resolve disputes:
Mediation is a process by which a mediator assists the conflicting parties in negotiating an agreement regarding the issue leading to conflict. Arbitration is when the conflicting parties present their conflict to a neutral third party who decides how to resolve the issue.
Shareholders should use a mediator or arbitrator when they are deadlocked over an issue. Mediation and arbitration are superior processes when a long-term relationship is involved, and the survival of the business relationship is desirable.
Step 17: Sign the agreement
Finalize your Shareholder Agreement by having all the shareholders sign the document.