Any business that has two or more shareholders or equity investors should seriously consider having a shareholder agreement to protect not only the shareholders but also the business itself. Too often, the shareholders of a start-up business are reluctant to spend the time or money to prepare an agreement that addresses the major areas of business operations or potential areas of dispute that may arise in a jointly owned and managed business.
While it is desirable to have an agreement that deals with most of the ongoing management issues in a business and the areas of potential disagreements, realistically the cost of preparing such agreement with successive meetings and drafts is not within the budget of a start-up business. However something is better than nothing, and a limited practical approach is to have what I like to refer to as a “Meanwhile Agreement.” This would take the form of two or three page listing of the most important areas of agreement between the parties without getting into the detailed “boilerplate” that usually finds its way into a 30-40 page agreement. There is always time and money available to prepare a detailed agreement when a business has evolved beyond the start-up phase and becomes profitable.
There is no such thing as a standard off-the-shelf agreement that is a one size fits all document. The most effective way to ensure your shareholder agreement meets the needs of the parties is to require the parties to be involved in the process of establishing the terms of the shareholders’ agreement. While a perfect Agreement is desirable, it is more realistic for the parties to feel comfortable that they can “live” with the terms of a point form or short Agreement for the time being.
So what are we talking about? A Shareholder Agreement is essentially a private contract made voluntarily by all shareholders of a business, that contains the following kinds of provisions (the listing is not exhaustive), even in the simplest of businesses:
- the names of the shareholders
- the number and class of shares held by each shareholder
- the amount of investment by each shareholder
- what happens if the business requires additional capital
- allocation of responsibilities as between the different shareholders in the operation of the business
- what happens if a dispute arises between the shareholders; do the parties wish to create a mechanism for one shareholder to buy out the other
- How decisions relating to the business will be made; unanimity, or in the case of 3 or more shareholders, does a majority of votes rule
- What happens if a shareholder dies; will the shareholders, or the business take out insurance on each shareholder’s life to provide funds for a buy-out on death;
- what happens if a shareholder becomes incapacitated and is unable to work full time
- What happens if a shareholder wants to leave the business
- Are shareholders required to work full time in the business
- Is any shareholder permitted to start another business, or do engage in a competitive activity
- Should there be a short start-up period where no shareholder can cause the corporation to be would up or be subject to a court action if there is a dispute among the shareholders (dishonesty would be an exception)
Without some agreement that deals with what happens if a dispute arises, any shareholder can apply to the court for an order winding up the business, not a desirable result. However, if the parties have addressed this issue in an agreement, even if it is a short one, the courts will give effect to the parties’ intentions.
A sample “Meanwhile Agreement” follows as an example. Do not use this sample agreement without proper legal advice.
For more information or to arrange an appointment to discuss this subject or for any other corporate services, call Frank at 416 565-6076.
“This article and the accompanying agreement is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.”
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Sample Agreement
MEMORANDUM OF AGREEMENT
THIS MEMORANDUM OF AGREEMENT (this “Agreement”) is made effective [date], between XXXX___ (“X”) and YYYY (“Y”) relating to X’s and Y’s rights as shareholders of XY Inc. (the “Corporation”) which was incorporated on [date]
FOR VALUABLE CONSIDERATION, the receipt and sufficiency of which is hereby acknowledged by each of X and Y (collectively, the “Shareholders”), the Shareholders hereby agree that the following provisions shall govern their rights and obligations as shareholders of the Corporation until this Agreement is modified, amended or replaced by another written Agreement:
- The Shareholders acknowledge that the provisions of this Agreement do not provide for all of the formal and detailed provisions that are normally part of a shareholders agreement and that they have jointly requested B Franklin Shostack Professional Corporation (the “Firm”) to prepare this Agreement on both their behalves and in accordance with their joint instructions. In this respect, the Shareholders acknowledge that all communications made by them to the Firm will not be subject to any obligation of confidentiality as between the Shareholders. The Shareholders further acknowledge that the Firm has advised them that it is appropriate for them to seek independent advice with respect to their respective rights and obligations as shareholders of the Corporation, and that they have declined to do so on the basis that this would not be a prudent expense at this point in the existence of the Corporation and the business it proposes to carry on. The Shareholders further acknowledge that, if a dispute arises between the Shareholders, neither Frank Shostack nor the Firm may act for either of them in connection with such dispute.
- It is the intention of the shareholders that they deal with each other in the utmost of good faith, and with full transparency regarding all matters affecting the Corporation and its business. If any matter arises in the course of the operation of the Corporation’s business that is not governed by the provisions of this Agreement, the Shareholders will use all reasonable efforts to resolve or determine such matter in a manner that is consistent with the intent of this Agreement.
- The Shareholders acknowledge and agree that the Articles of Incorporation of the Corporation are set out in the Schedule “A” and that:
- The shareholders will each own 50% of the voting common shares, with X owning 100 Class A common shares and Y owning 100 Class B common shares, which shares will rank equally in all respects except that payment of declared dividends on either class of shares may be deferred;
- The Class A special shares, Class B special shares and Class C special shares are non-voting, and are reserved for possible issue to employees who will be entitled to share in profits or wish to receive part of their compensation in the form of dividends but who would otherwise not participate in the growth of the Corporation;
- The Class AA special shares, Class BB special shares and CC special shares are non-voting, and are reserved for issue to employees who will be entitled to share in profits or who wish to receive part of their compensation in the form of dividends and, in addition, who will qualify for participation in the growth of the Corporation; and
- Effective at the date of incorporation, or shortly thereafter, X shall subscribe for and be issued 100 Class A common shares for a subscription price of $1.00 per share. Y shall subscribe for and be issued 100 Class B common shares for a subscription price of $1.00 per share.
- The following provisions shall govern management and decision-making of the Corporation:
- The business of the Corporation shall be to: _____________________. Expansion of the business beyond the foregoing parameters shall require agreement of both Shareholders;
- The Corporation shall have two directors, being X and Y. At the outset following incorporation, X shall be the President and Secretary of the Corporation. On or shortly after _____________, X shall resign as Secretary and Y shall be appointed as Executive Vice-President, Operations and Secretary-Treasurer. As an alternative to or in addition to the foregoing, for marketing purposes, X and Y may each have business cards with a title of Managing Partner;
- All decisions relating to the operations of the business, and all decisions that would otherwise be within the authority of the directors of the Corporation, shall require the agreement of both Shareholders; and
- If appropriate, the Shareholders shall allocate their day-to-day responsibilities which shall be set out in a written memorandum which shall be attached to and form part of this Agreement.
- The initial budget for the operations of the Corporation is set out in Schedule “B” attached hereto. For each year after the period covered by the initial budget, the Shareholders shall agree upon a budget for the next fiscal or other period of the Corporation’s operations which shall govern the financial operations of the Corporation for such period, subject to any variations that may be agreed upon by the Shareholders. The Shareholders acknowledge that the initial budget provides for an investment by them of $__________ in the aggregate. For this purpose, they shall each contribute $___________ by cheque payable to the Corporation, to be deposited in the Corporation’s bank account, of which $100 shall be as a subscription price for the common shares to be issued to them respectively and the remainder shall be recorded as a shareholder advance. In order to ensure that the Corporation has sufficient funds for its operations, the Shareholders have agreed to make available, as a contingency, an additional amount of $15,000 each to be treated as a further shareholder advance. Such amounts shall be advanced to the Corporation if the cash flow of the Corporation is insufficient to meet the Corporation’s day-to-day obligations. Either of the Shareholders may request such contingent advances to be made at any time where it reasonably appears that the Corporation’s available cash flow will not be sufficient. All such shareholder advances shall be secured by a general security agreement over the assets of the Corporation, jointly held by the Shareholders. All payments in respect of the shareholder advances shall be made in equal amounts to the Shareholders.
- If, during the Initial Period referred to in paragraph 8 below, either of the Shareholders, acting reasonably, determines that the Corporation requires an additional cash injection, if both Shareholders agree, such additional cash will be provided by them equally and the amount of such investment shall be added to the shareholder advances owing by the Corporation to them. If one of the Shareholders is unwilling or unable to make such advance, the other Shareholder may advance to the Corporation such amount as is reasonably required to meet the Corporation’s cash requirements (an “Additional Advance”). The Additional Advance shall bear interest at the rate of 5% above the prime rate charged by the Corporation’s bank to be payable monthly, and shall be repayable in priority to all other shareholder advances out of the Corporation’s available cash flow and, in any event, shall become repayable within one year from the date on which such Additional Advance is made. If an Additional Advance has not been repaid in full within one year of the date it was first advanced to the Corporation, then the Shareholder who has not made the Additional Advance shall be required, within 30 days thereafter, to advance to the Corporation an amount equal to the outstanding balance owing by the Corporation on account of the Additional Advance.
For each $10,000 of Additional Advance not equalized, the party making the Additional Advance will have the right to subscribe for such number of common shares as will increase such Shareholder’s participation in the Corporation by the percentage that the Additional Advance represents of the total advances.
- Within a reasonable period of time after the Corporation’s operations have been established, the Corporation shall apply to a Canadian chartered bank selected by the Shareholders for an operating line in such amount as such bank is willing to extend to the Corporation, and the Shareholders shall jointly and severally guarantee such operating line of credit. The availability of such operating line of credit shall replace the foregoing provisions relating to the making of an Additional Advance.
- For the first three (3) years of the operations of the Corporation (the “Initial Period”), neither of the Shareholders shall be entitled to cause the Corporation to be dissolved or wound up, and the parties have intentionally refrained from providing for any kind of buy-sell provisions in this Agreement. If any dispute arises between the Shareholders during the Initial Period, the Shareholders shall refer such matter to ___________________ Professional Corporation, being an independent third party.
- During the initial period of the Corporation’s operations, the salaries to be paid to the Shareholders shall be the amounts respectively set forth in the initial budget, recognizing that Y will be on maternity leave for part of such initial period. After Y’s return to full time work, salaries payable to her and X shall be equal unless otherwise agreed to in writing by them.
IN WITNESS WHEREOF the parties hereto have executed this agreement as of the day and year first above written.
| SIGNED, SEALED AND DELIVERED in the presence of | ||
| Witness | X |
| SIGNED, SEALED AND DELIVERED in the presence of | ||
| Witness | Y |