Minden Gross LLP - Dividend/Good Dividend

The Shareholders Agreement

By: Ryan Gelbart

Minden Gross LLP, a member of MERITAS Law Firms Worldwide.

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When a company is created, its founding shareholders determine how the company will be owned and managed. This is often set out in a written contract amongst the shareholders called a shareholders agreement. There is no legal requirement for the shareholders to enter into a shareholders agreement but in the absence of a shareholders agreement the company will be governed by the basic provisions contained in the applicable corporate statute (i.e. the Ontario Business Corporations Act or the Canada Business Corporations Act) together with the company’s articles of incorporation and by-laws. In most cases these basic corporate rules are not sufficient, for example absent a shareholders agreement, there is no way to force the sale of a shareholder's shares, this can result in companies becoming deadlocked or unable to react in a timely manner to pressing business issues. Therefore it is desirable for a shareholders agreement to be entered into in order to provide a more detailed set of “ground rules” which are specifically tailored to fit the circumstances of the company and the shareholders.

There is no such thing as a “one size fits all” approach to preparing a shareholders agreement.

Careful planning and consideration must be given by shareholders and counsel in order for the agreement to address issues which are relevant today and plan for the various scenarios that could potentially arise throughout the life of the company.

Matters often addressed in a shareholders agreement include:

1. General Decision Making

Which decisions are to be made by shareholders and which decisions areto be made by directors? (i.e. corporate decisions vs. operational decisions)

How are decisions made? (i.e. majority vote vs. super majority vote vs. unanimity)

How are disputes resolved?

Who has the right to be on the board of directors or to nominate a director?

Is the agreement a “unanimous shareholder agreement”? (i.e. restricting the rights of directors by the shareholders)

Who is permitted to sign cheques and contracts on behalf of the company?

2. Financing the Company and Distributing Profits

How is the company financed? (i.e. loans vs. equity)

Is third party financing permitted?

What if personal guarantees are required?

How and when are profits distributed?

3. Share Transfer Restrictions

Are transfers permitted in certain circumstances? (i.e. to family members,
holdings companies or family trusts)

When can further shares be issued?

Are there anti-dilution protections?

4. Liquidity

Are there Shotgun or Buy Sell provisions

Rights of purchase on death or permanent disability of a shareholder

Rights of first refusal

Sales to third parties

Other liquidity events (i.e. bankruptcy, termination of employment, Family Law Act claims by spouses)

Confidentiality, non-competition and non-solicitation restrictions following a sale of shares

Often when dealing with a start-up company with limited financial resources, a shareholders agreement is viewed as an unnecessary expense because it does not contribute to the immediate success of the underlying business.

Start-up shareholders often cannot foresee the consequences that a future dispute will have on the operation and value of the business or consider it unlikely that such a dispute will ever arise. It is our experience that one of the biggest mistakes which entrepreneurs make is not entering into a shareholders agreement. Although the immediate value of a shareholders agreement is difficult to quantify its importance should not be discounted.

Entering into of a shareholders agreement at the early stages of a company will help the founders to develop a common understanding regarding their roles and contributions to the company and will turn their minds to issues which are relevant at all stages of the business which they otherwise would not have considered as a group.