Startup founders usually aim for the stars. What could possibly go wrong with expansive vision, high spirits, and grand plans? Unfortunately, quite a few things. Building a successful business demands a solid foundation and forethought to manage overwhelming difficulties. A well-prepared shareholders’ agreement can serve as a road map through the predictable and unanticipated ups and downs of starting a new corporation. While it may not be the most romantic way to begin a business, founders should ensure that a professionally drafted shareholders’ agreement is in place as soon as possible. Here are some important reasons you may want to draft a shareholder agreement.
A Partner Wants to Sell Ownership to An Outside Investor
Shareholder agreements can forbid shareholders from transferring ownership to third parties. By including a first right of refusal, the selling partner must provide the other shareholders in the business the opportunity to buy out the partner’s ownership interest.
Conversely, What If a Third Party Wants to Purchase 100% Of the Company?
This can be the subject of a heated debate among shareholders. Avoid complicated stalemates by inserting a drag-along clause in shareholder agreements. A drag-along clause allows major shareholders to force minor stockholders to sell their shares in specified conditions when the major shareholders agree (i.e., the majority shareholders drag along the remaining minority shareholders in selling the company).
In most cases, this clause stipulates that all shareholders receive an equal purchase price and a valuation method for the shares in the event of a disagreement, so all shareholders receive a fair and even value for their shares.
How Can a Minority Shareholder Retain Power Over the Company’s Governance?
A majority of shareholders (usually 51 percent) is usually necessary to appoint and remove directors from the board, allowing effective control of the corporation. However, despite holding up to 49 percent of the shares, a minority shareholder will not have the right to representation on the board. In that instance, a shareholder agreement may grant a minority shareholder the power to appoint a director if they own a certain percentage of the company’s stock (e.g., 25 percent). A shareholder agreement’s “restricted activities” clause may also demand a “super-majority” of shareholders (e.g., 75 percent or more) before making certain decisions, such as engaging in a big transaction, hiring important personnel, paying dividends, or issuing new shares. This ensures that minority shareholders retain some power over the company’s governance.
A Partner Wants to Leave the Business, Will They Get to Keep the Shares?
Unless otherwise specified in the agreement, a departing partner will keep their shares and reap the benefits of ownership regardless of whether or not they add value to the business. Shareholders frequently agree that a departing shareholder should not be able to keep the entire value of their shares if they are no longer contributing to the corporation. A shareholders’ agreement can be written to incorporate terms that encourage or prohibit a shareholder from transferring their shares without the approval of the other shareholders. It can also grant existing stockholders first refusal and compensate inactive shareholders.
How Can I Protect the Company’s Interests If a Partner Leaves?
A shareholder agreement may include non-competition, non-solicitation, and confidentiality clauses that prohibit an individual from establishing a competing business in a specific area within a specified time. It can also prevent a former founder from poaching employees and customers, and the publication or transfer of confidential company information.
Contact Our Experienced Corporate and Business Contract Attorneys
When you are excited about a new endeavor, it can be easy to underestimate the importance of a suitable and responsible legal foundation at the outset. Key provisions in the shareholders’ agreement can help eliminate ambiguity by pre-determining the procedure for resolving issues and assuring a fair resolution.
Beress & Zalkind PLLC is a boutique law firm devoted exclusively to the practice of Trusts and Estates, Corporate/Business, Real Estate, and Tax law. We have helped clients just like you avoid the pitfalls involved when key agreements are not put in place at the outset of a business relationship. If you are in New York, New Jersey, or Florida, we would love to hear from you!