Shareholders Agreements

There are a number of reasons to have a shareholders agreement, particularly if your corporation has relatively few shareholders and most or all of them work for the company. For example, you may want to

  • Keep stock issued by the corporation or sold by a shareholder with remaining shareholders as much as possible.
  • Preserve the same percentages of ownership as much as possible.
  • Require departing employees to sell their stock so that the stock remains with those who have the greater incentive.
  • Require the corporation to buy a shareholders' shares if he/she becomes disabled or dies.
  • Give one or more shareholders an option to force the corporation to purchase their shares in certain situations. (This is great for the shareholders but may cause the corporation hardship).

In deciding to create a shareholders agreement, you need to consider the following:

Do you want to give the corporation and/or the other shareholders a right of first refusal if a shareholder wants to sell his or her stock to outsiders? Doing so makes it much more likely that the stock will be kept "within the family," rather than going to people who may not have their hearts and souls invested in the company or who may have a radically different idea of what they want the corporation to do?

If a shareholder sells stock to another shareholder, do you want to give the other shareholders a right to purchase enough of those shares at the same price to maintain the size of their holdings in comparison to the other non-selling shareholders? One problem that can arise without such a provision, for example, is that if one minority shareholder sells to another minority shareholder, the purchasing shareholder may obtain a controlling interest in the corporation.

Do you want to give the corporation and/or the other shareholders an option to purchase shares from a shareholder who ceases to be at least a part-time employee of the corporation; transfers shares by Court order regarding divorce to a former (or soon to be former) spouse; transfers shares without receiving money for them (for example, as a gift); or attempts to dissolve the corporation.

With respect to employment, should this provision apply only when the employee voluntarily leaves the company? If it applies to involuntary terminations, those with control may fire the employee in order to be able to purchase his/her stock.

What method will be used to set the sale price of the stock?

An outside appraiser can be used. However, this tends to be expensive.

The shareholders can set the initial price and agree to set the price each year. If the shareholders fail to do this, the last price set can be used, along with an annual percentage increase.

A formula based on revenues or profits may be used. For example, the formula might be a per/share price of one times average annual earnings of the company (divided, of course by the total number of outstanding shares). The multiplier varies dramatically from industry to industry.

Book value plus goodwill may be used. One method here is to set goodwill according to a formula, such as multiplying by ______________ times the excess of (1) the average annual net earnings of the Corporation over (2) ___________ percent ("Rate of Return") of the Corporation's average book value. Again the multiplier and percent vary widely from industry to industry.

Negotiation between the parties, followed by arbitration if they cannot agree. However, arbitration can be expensive and take time.

The price for the last sale of shares. But this is obviously a problem if a great deal of time has passed since the last sale.

A combination may be used. For example, the higher of a formula based on revenues or profits or book value plus goodwill or the price for the last sale of shares.

Do you want to restrict shareholders from selling their stock until a certain date is reached? Especially with a start-up, you may want to give the corporation a chance to become financially successful before you allow sales of stock. Otherwise, stock may be sold at a low price, which may create image problems.

Should a shareholder (or his/her estate) be given an option of forcing the corporation to purchase his/her stock if: he/she dies, he/she is involuntarily terminated, he/she becomes disabled?

Should the corporation or the other shareholders be allowed to pay with a promissory note? What size should the down-payment be, if any? What interest rate and term should be used?

If both the corporation and the other shareholders have purchase rights, who has priority, the corporation or the other shareholders?

Should a buy-out upon the death of a shareholder be funded with life insurance where the corporation pays the premiums? Obviously, these answers will vary from corporation to corporation.

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The foregoing article constitutes general information only and should not be relied upon as legal advice.