Shareholder Agreement

An arrangement that defines the relationship between shareholders and the company

Written by CFI Team

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What is a Shareholder Agreement?

A shareholder agreement outlines how a company is to be operated, the rights and
obligations afforded to the shareholders, and the relationship between the company
and the shareholders. It is similar to a partnership agreement, which is an arrangement
between the various partners in a business.
The purpose of a shareholder agreement is to ensure that shareholders are protected
and treated fairly, and it allows them to make decisions on the third parties who may
become shareholders in the future. Although it is designed to protect all shareholders, a
shareholder agreement is more important to minority shareholders since it outlines the
majority shareholders’ obligation to protect minority shareholders against abuse and
give them a voice when key decisions are made.
 Summary

 A shareholder agreement is an arrangement that defines the relationship between

shareholders and the company.
 The agreement safeguards the rights and obligations of the majority and minority
shareholders, and it ensures all shareholders are treated fairly.
 It protects continuing shareholders from decisions of future management or if the
company is sold.

Shareholder Agreement Explained

The shareholder agreement helps protect the interests of current shareholders from
cases of abuse by future management. If there is new management or the company is
acquired by another entity, the agreement helps safeguard certain decisions such as
dividend distribution and issuing of new stock or debt.

Some of the issues covered in the shareholder agreement include dealing with
shareholders’ issues, corporate distributions, the management team of the company and
limitation on authority, rights of minority shareholders, valuation of shares, voting of
shares of stock, restrictions on the transfer of shares, allotment of additional shares, etc.
The agreement protects shareholders, and it can be used as a reference document if
there are disputes in the future.

How Shareholder Agreements Protect Minority Shareholders

Minority shareholders lack voting control of the company, and in the absence of a
shareholder agreement, these shareholders will exert minimal influence in the running
of the company. Key management decisions can be made by the few controlling
shareholders who own more than 50% of the company, and they may not consider input
from the minority shareholders.

Even if the articles of association protect the minority owners, the provisions can often
be altered through special resolutions approved by the majority shareholders. The
shareholder agreement may address these loopholes by requiring that key company
decisions be approved by all shareholders regardless of their voting power.

Such rules limit the ability of the majority shareholders to overrule minority shareholders
when making certain decisions, such as the issue of new shares, taking new debts, and
the appointment and removal of directors, etc.

How Shareholder Agreements Protect Majority Shareholders

Apart from protecting the minority shareholders, the shareholder agreement may also
protect the majority shareholders where minority shareholders are uncooperative. For
example, majority shareholders may require the inclusion of a drag-along provision that
allows them to sell part or all of the shares at a specific time and price even if the
minority shareholders are unwilling to agree on the transaction.

Also, the shareholder agreement may include a clause that prevents minority
shareholders from transferring their shares to a competitor or other party that majority
shareholders do not want to get involved in the company. The agreement should also
define rules on the sale and transfer of shares, who can purchase shares, the terms and
prices, etc.

What is Included in a Shareholder Agreement?

The contents of a shareholder agreement may vary across companies. Some of the
contents of a shareholder agreement include:

1. Parties

The first section of a shareholder agreement identifies the corporation as one party that
is different from the shareholders (another party).

2. Board of Directors and Board meetings

The shareholder agreement describes the role of the board of directors in the company
and the requirement that decisions of the board should be approved by the majority. It
also states how frequently the board of directors should hold meetings and how
directors are selected and replaced.

3. Reserved Matters

The shareholder agreement should set out issues that cannot be passed without getting
the approval of all signatories, not just majority support. By creating a list of reserved
matters, all shareholders are given the chance to vet certain transactions to determine if
they are prejudicial to their investment.

Some of the commonly reserved matters include changing share capital, acquiring or
disposing of certain assets, taking on new debt, paying dividends, and changing the
articles of association and memorandum.

4. Shareholder Information and Meetings

The shareholder agreement should include a requirement that shareholders are entitled
to regular updates on the company’s performance through quarterly reports and an
annual report. It should state the specific period when the reports should be sent out to
shareholders. The agreement should also state when shareholder meetings will be held
and the time, date, and venue of the meetings.

5. Share Capital and Share Transfers

The shareholder agreement should record the corporation’s share capital at the date
when it is signed. Since changing share capital is one of the reserved matters, the
directors are prohibited from issuing new shares or changing existing shares into a new
share class without the signatories approving the changes.

The shareholder agreement also contains provisions relating to share transfer, such as
preventing share transfer to unwanted parties, transferring shares to a new party, what
happens if a director or shareholder dies, as well as drag and tag provisions.

6. Amendment and Termination

The process of amending or terminating the shareholder agreement should be provided

in the agreement. For example, the shareholder agreement may be terminated upon the
dissolution of the company, based on a written agreement, or after the lapse of a
specific number of years from the date of the agreement.

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Shareholders’
Agreement: Everything
You Need To Know

By Ownr Team • Read Time: 4 minutes

Updated on: Dec 7, 2023

What is a Shareholders’ Agreement and how might it benefit your business? In this
article, we’ll explain the purpose of a Shareholders’ Agreement and why many
businesses choose to have one prepared early on. We’ll also provide you with a
rundown of all the jargon you’ll find in a Shareholders’ Agreement—from piggyback
rights to shotgun clauses!

What is a Shareholders’ Agreement?

A Shareholders’ Agreement is first and foremost a contract between the owners of a
company. It’s often called the business prenuptial agreement as it lets the owners of a
company map out a process to resolve disputes and add rules for managing the
company and ownership structure. Important provisions within a Shareholders’
Agreement include the decision-making powers of directors and shareholders,
restrictions on the sale and transfer of shares, and the process for resolving disputes.

If you’re the only owner of your business, then you won’t need to worry about a
Shareholders’ Agreement.

Why does your business need a Shareholders’

Agreement?
1) Decision making and disputes
When you start your business, you and your partners may expect smooth sailing going
forward. But conflicts are inevitable in business, and shareholder disputes can
contribute to the failure of small businesses all too easily. With a Shareholders’
Agreement in place, you can proactively decide how you plan to resolve specific
issues productively, including specifying dispute resolution mechanisms that are
agreed to in advance.

Also, the laws governing corporations in Canada give extensive powers to a

company’s directors. In some companies, this legal default situation is satisfactory
and the directors can make all important decisions for the company. In other
companies, particularly small and growing companies, the shareholders want to
directly make important decisions without relying upon the directors. A Shareholders’
Agreement can be used to transfer these decision making functions from directors to
the shareholders.

2) Controlling the transfer of shares to new owners

You and your partners probably have a good understanding of your relationship with
each other as you start your company. But over time, as your business grows and as
you consider adding new owners, things can change. Removing or adding any team
member can have a huge impact on your entire company.

Think about the effect on your business if your partners can transfer their shares freely
to anybody they choose. Suddenly, someone whom you don’t know could be making
decisions for your company alongside you.

That’s why a Shareholders’ Agreement will often impose restrictions on the transfer
of shares. Restrictions can include requiring all shareholders to agree before any one
of them can sell shares as well as providing existing shareholders the first opportunity
to buy shares of a departing shareholder.

3) Exit
What happens if one of your partners wants to leave the company. Can one partner
buy another out?

To this end, one option in a shareholders agreement is to include a shotgun clause or a

“buy-sell provision.” This simple mechanism provides the structure under which one
partner can buy the shares of a partner who wishes to leave the company, with all
terms pre-negotiated to prevent disputes. Without a shotgun clause, this type of
dispute may lead to litigation or even the dissolution of the company.

Relationship building with your partners

Even the process of building a Shareholders’ Agreement benefits your business, as it
puts you and your business partners in a position where you are required to have an
open and honest dialogue about subjects that might otherwise go unspoken for years.
Your team is likely to come out feeling stronger thanks to the realization that you’re
all on the same page and if a conflict arises, you’ve already done the hard work to
come to a fair and equitable resolutions.

Legal jargon and terms you’ll find in a Shareholders’

Agreement
There’s a lot of terminology that’s unique to a Shareholders’ Agreement. We
explained the most common terms below:

Drag Along Right requires minority shareholders to sell their shares once the
majority shareholders have agreed to sell the company.

Piggyback Right the opposite of a drag along right, it’s intended to protect minority
shareholders by requiring any offer to purchase shares from the majority shareholders
to also make the same offer to all minority shareholders. The minority shareholder
would then have the option to sell their shares to the buyer. This is also referred to as
a tag-along right.

Put Clause gives the shareholders the right to require the company to purchase their
shares back from them at any time. It’s also referred to as a ‘Buy-Back’ clause.

Non-Competition Clause prevents a shareholder from becoming involved with one

of the business’s direct competitors for a specified time period and location.

Non-Solicitation Clause prevents a shareholder from trying to solicit the business’s

clients or employees for another company.

Right of First Refusal provides that if one shareholder has received an offer to sell
their shares, all other existing shareholders have the first opportunity to match that
offer to purchase the shares.
Right of First Offer slightly different than a Right of First Refusal clause, a Right of
First Offer clause sets out that a shareholder who wishes to sell their shares must first
offer those shares to existing shareholders at a specific price. It’s only after no other
existing shareholders choose to purchase the shares that the shareholder is free to sell
to anyone, so long as the price of the shares is equal to or higher than the original
offer.

Shotgun Clause outlines a process for one shareholder to sell their shares and leave
the company or require the remaining shareholders to purchase their shares. One
shareholder can set a price for the company’s shares and the other shareholder(s) must
then either sell their shares at that price or purchase the shares belonging to the
shareholder who set the price.