Does Your Company Need a Shareholder Agreement?

A shareholder agreement is a legal contract between the shareholders of a corporation. It defines the rights and responsibilities of each shareholder, as well as their obligations to one another and the corporation itself.

While shareholder agreements, also known as stockholder agreements, are optional, they are frequently used by closely held corporations. These companies typically have a small number of shareholders with concentrated ownership. In many cases, shareholders are also involved in the daily operations of the business, which can create complex and potentially conflicting relationships.

When professionally drafted by an attorney, a shareholder agreement can minimize the risk of future disputes and promote the long-term stability and success of the company.

Why Conflicts Can Arise in Closely Held Corporations

When people think of corporations, they often imagine large companies with publicly traded shares, a wide base of shareholders, and professional management. However, most corporations are smaller, closely held businesses, owned and controlled by a small group of shareholders. In these types of companies, shareholders may also serve as directors, officers, or employees, meaning the lines between ownership and control are often blurred.

Moreover, in closely held corporations, shareholders frequently have personal relationships—such as family ties—beyond their business interests. These intertwined relationships, combined with the financial stakes involved, can create tension and lead to conflicts among shareholders.

Shareholder disputes are one of the most challenging and potentially damaging issues for closely held corporations. Problems may arise if majority shareholders attempt to take actions that disproportionately benefit themselves at the expense of minority shareholders. On the other hand, minority shareholders might have conflicting interests that differ from those of the majority and the company as a whole.

Corporate charters and bylaws may not fully address these kinds of complex, potentially conflicting relationships in closely held corporations. A shareholder agreement can bridge this gap and help prevent conflicts from arising.

How Shareholder Agreements Can Help

A well-crafted shareholder agreement sets clear guidelines for managing and operating a closely held corporation. It can help prevent disputes, protect shareholders’ interests, and ensure the business’s long-term stability and continuity.

Some of the essential issues addressed by shareholder agreements include:

Clarifying Rights and Responsibilities: The agreement outlines the specific rights, duties, and responsibilities of each shareholder. This helps ensure everyone understands their role in the corporation, reducing the likelihood of misunderstandings about management, decision-making, and profit-sharing.
Protecting Shareholder Interests: Provisions like rights of first refusal, tag-along rights, or antidilution protections safeguard the interests of minority shareholders. These protections help ensure that majority shareholders cannot treat minority shareholders unfairly.
Decision-Making Procedures: A shareholder agreement can set up clear procedures for making decisions and allocating voting rights. This framework helps resolve disputes and facilitates key decisions, such as acquisitions or strategy changes, ensuring stability and efficiency even when shareholders have differing opinions.
Managing Transitions and Exits: Shareholder agreements often include buy-sell provisions that establish procedures for handling ownership changes, such as when a shareholder wants to sell their shares or becomes incapacitated. Without these guidelines, companies can experience costly disruptions during ownership transitions.
Maintaining Confidentiality and Preventing Competition: Confidentiality clauses in shareholder agreements can protect sensitive corporate information from being disclosed to outside parties. Additionally, restrictive covenants can prevent shareholders from engaging in competitive activities that could harm the corporation.
Resolving Disputes: The agreement may outline mechanisms for resolving disputes, such as mediation, arbitration, or buyouts, providing a structured approach to conflict resolution.

Shareholder agreements act as a blueprint for addressing a variety of potential scenarios that may arise during the corporation’s lifecycle.

The Importance of a Well-Drafted Shareholder Agreement

Shareholder agreements are not one-size-fits-all solutions. While a well-drafted agreement can help prevent and resolve issues, a poorly written one can create new problems, potentially leading to expensive litigation. Therefore, it’s crucial that the agreement is crafted with a deep understanding of your company’s goals, as well as the personalities and dynamics of the shareholders.

If you need assistance in drafting a shareholder agreement that aligns with your company’s specific needs, our small business attorneys are here to help. Contact us to schedule a consultation and ensure your company is protected for the future.