If you are acquiring or currently own shares of stock in a closely held corporation with other persons or entities, should you enter into a shareholder agreement?
Yes! A shareholder agreement governs the ownership relationship between the shareholders and the corporation. It can be between some of the shareholders, or all of the shareholders, and the corporation. A shareholder agreement usually addresses various matters, including, but not limited to, transfer restrictions with respect to the shares of stock, a buy-out of the shares of stock owned by a shareholder upon certain events, i.e. death, disability or termination of employment, and governance issues. Many of the terms of a shareholder agreement will be negotiated among the parties.
Majority Shareholder or Equal Shareholder
- It can prevent the other shareholder from transferring shares of stock to a third party.
- It can cause a buy-out of the shares of the other shareholder upon certain events, so the majority or equal shareholder, as applicable, does not have to deal with a stranger or someone who no longer works with the corporation. Such buy-out events would include:
- Termination of employment;
- Involuntary transfers; and/or
- Pledging of stock.
- It can set out the purchase price and terms of purchase for the shares of stock to be acquired from the other shareholder. Certain events may cause a discounted purchase price, i.e. a termination of employment “For Cause,” employee leaves employment or a required capital contribution is not made by a shareholder. There may be a formula or procedures inserted in the shareholder agreement for the method of determining the purchase price for the shares of stock.
- It can provide for a drag along right, whereby if a majority or equal shareholder is selling his, her or its shares of stock to a third party, such shareholder can require the other shareholder to also sell his, her, or its shares of stock to the third party (usually at the same price and terms).
- It may set out a dispute resolution procedure in the event of a conflict among the shareholders and/or the corporation providing for:
- Shot gun buy-out provision (also referred to as a push-pull provision) (generally used when the ownership of stock is 50/50);
- Shareholder vote in the event of management dispute;
- 3rd party mediator; and/or
- “Call” provision that requires the other shareholder to sell his, her, or its shares back to the corporation.
How may a shareholder agreement protect the minority shareholders?
- It may guaranty a buy-out of the minority shareholder’s shares and a certain purchase price upon certain events. Such events would include:
- Termination of employment by employee resulting from a change of duties or relocation;
- Termination by the employer for reasons other than “For Cause;”
- Death; and/or
- Transfer of controlling ownership by a majority shareholder (tag-along rights).
- It may give the minority shareholder preemptive rights in ownership of the corporation, so that the minority shareholder’s percentage of ownership is not decreased without first giving such shareholder an opportunity to participate in the share offering to retain ownership percentage.
- It may require a super majority vote (certain minority vote needed) for certain actions of the corporation. Such actions generally would include:
- Appointing or removing certain directors or officers;
- Selling the business;
- Borrowing money;
- Paying dividends;
- Giving bonuses to management in excess of a certain amount;
- Entering into another area of business; and/or
- Requiring capital contributions.
As provided above, the terms of a shareholder agreement are generally subject to negotiation between the shareholders and/or corporation, and thus many of the above considerations or protections mentioned above may not end up in the final version of the shareholder agreement.
To learn more about shareholder agreements, contact Christy Woods at email@example.com or call 239-514-1000.
[Please note the above comments are not intended to be all inclusive and there are additional items that need to be considered when entering into a shareholder agreement. Additionally, the above commentary is not intended to give legal business advice]
Christina Woods has practiced law in Southwest Florida since 2005 and has more than fifteen years of experience representing closely held and family owned businesses. She focuses her practice area on mergers, acquisitions, formation and disposition of business entities. In addition, she addresses matters involving the operations of business entities, entity ownership, entity structure, individual tax planning, and business tax planning.