A shareholder agreement should be executed when two or more people form a corporation. The agreement lays out the rules in regards to stock ownership, corporate management, and conflict resolution.
While there’s no one-size-fits-all approach to creating the agreement, there are certain key provisions that are common to most. Keep in mind that shareholder agreements can be updated as business needs change.
Shareholder agreements include basic information about corporate management, establishing rules regarding the Board of Directors, observer rights, and procedural details for board meetings.
For the Board, the agreement can establish the number of directors, the tenure, and voting rights. Observer rights allow investors who aren’t on the board to be present at board meetings.
Shareholder agreements typically include rules about the protection of proprietary information. This clause mandates that shareholders maintain confidentiality of key business information such as consumer data, IT innovations, methodology, and whatever else the corporation considers confidential. To further protect the company, a breach of confidentiality can trigger an automatic buyback.
Also described as “covenants of the corporation,” this provision requires the corporation to fulfill certain reporting obligations. For example, this provision might require the corporation to provide quarterly and annual financial statements to shareholders, and may also set out legal recourse for shareholders who do not receive required information.
Mandatory Buybacks in Case of Death
Most shareholder agreements include provisions for the buyback of stock in case of death. The event triggers an automatic buyout by the company, to prevent shares from passing to spouses or children.
In case the corporation can’t afford the shares at the time of death, then the shareholders are obligated to purchase them.
Typically, this provision also necessitates a “consent of spouse.” This clause will be signed by the spouse of the shareholder, having them waive any property rights to the shares of the deceased shareholder.
Restrictions on Transfer
This provision does exactly what it says, restricting shareholders from freely trading shares. Generally, this provision includes a “right of first refusal” to the corporation and other shareholders, giving them the option to purchase the shares before they are sold externally. The corporation and its shareholders may waive the option, but there are many cases where they’d want to keep the shares in the company.
Optional Triggered Buyouts
Death isn’t the only circumstance that can trigger automatic buybacks. A shareholder agreement might include provisions that allow the corporation and other shareholders to buy out a single shareholder.
Examples of these circumstances include:
- Bankruptcy of the shareholder.
- A shareholder’s failure to perform required responsibilities.
- Mental or physical disability of a shareholder.
- Retirement of a shareholder.
- Anti-trust or anti-competitive behavior by a shareholder.
Method of Buyout
A shareholder’s agreement typically includes a separate section detailing the mechanics of a buyout. This section will describe:
· How the corporation determines the price of repurchased shares.
· The required notice period before shares are repurchased.
· The timeline for making payment for the repurchase.
· The timeline for completing the transfer of stock.
Drag-along rights are an essential provision for companies who foresee a need to sell the entire corporation in the future. In the case where shareholders can’t come to a unanimous agreement about selling the company, drag-along rights allow the sale to happen anyway, provided that a defined majority of shareholders agree to the sale.
However, a drag-along clause typically protects the “dragged along” shareholders, by including a minimum purchase price, limiting warranties and other special provisions that shareholders are required to provide, and setting terms on what type of equity can be used to make the purchase.