Planning is essential to the success of any business. Many owners have well-written plans for operating their businesses, but very few have an effective plan to deal with issues that may arise between shareholders. It’s essential that businesses with multiple shareholders have properly structured shareholders agreements in place to protect everyone’s interests.
A shareholders agreement is a business contract that governs the relationship between the shareholders. When properly structured, they can help regulate a company’s operations should this relationship fail or should one party need to leave the company.
The best time to implement an agreement is when business is good. Shareholders are happy and everyone is talking. Waiting until one of the “D” life events occurs with a partner (death, disability, divorce) is too late.
Failure to plan properly could have a serious impact on the company, and impact the shareholders’ abilities to realize value on their shares. A well-drafted agreement can also be used as an efficient and effective mechanism for business succession, either to the next generation or to a third party.
No two businesses are alike. While there are a number of issues such as shareholder compensation (e.g., dividend policies), maintaining adequate insurance (on key employees and shareholders) and operating guidelines, this article deals primarily with those shareholder agreement provisions dealing with the departure of a shareholder. If dealt with properly, the company can continue to run smoothly when faced with circumstances such as death, disability or a shareholder’s retirement.
A properly structured shareholders’ agreement generally includes the following provisions:
- Determining current and future share ownership
- Ensuring an orderly transition for a shareholder departure
- Restricting the ownership and transfer of shares
- Providing a market (or value) for share transfers
- Protecting the interests of minority shareholders
- Provide a way to resolve shareholder disputes
With these overall objectives in mind, a well-thought-out agreement should be implemented to address shareholder and business-specific issues. Before drafting an agreement, you should address the following questions:
- What will happen if a shareholder leaves the company?
- Will the departing shareholder be subject to a non-competition clause?
- How will a passive shareholder be compensated compared to an active shareholder?
- Can a deceased’s family member become a shareholder of the company?
- Who can purchase the shares and at what price?
- How will the shares be valued?
- How should the buyout be structured to minimize tax and cash flow?
- How will the remaining shareholders fund the buyout?
Once you’ve addressed these questions, you need to consider some typical strategies which I will cover in next week’s financial article. When developing an agreement, each shareholder needs to realize that, for their protection they should obtain their own independent professional tax, legal and accounting advice.
The followup article can be found at, When Business Partners Need a Shareholders Agreement, Part 2
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