Why you need a shareholder agreement before you start doing business

by | Aug 9, 2021 | Firm News |

Whether you have a small corporation or a mid to large-sized one, you need a well-crafted, thorough and air-tight shareholder agreement in place. It’s not a legal requirement, but having a shareholder agreement can help your company to avoid many challenges and setbacks that you otherwise would have. Here are a few reasons why it’s best to put into place a shareholder agreement before you open your doors for business.

What shareholder agreements do

A shareholder agreement is a contract that all shareholders must sign before they can own stock in your company. It outlines the rules that they must follow when buying, selling and using their stock to vote on corporate governance issues. It also gives them certain rights, and recourses for if those rights are violated.

For example, many shareholder agreements give the shareholders a process whereby they can vote to remove an officer of the company if they agree that it is in the best interest of the company to do so. Conversely, such agreements can also restrict who shareholders can sell their shares to, thus allowing the corporation’s officers to retain a certain level of control over who is making the decisions for the company.

Why you need one

A shareholder agreement can minimize the probability of a successful derivative lawsuit against you or another officer. Since the shareholder and the company’s officers agreed to certain rights and responsibilities beforehand, everyone’s expectations are clear. Thus, if a shareholder is unhappy with a decision you have made for your company, and wants to bring a derivative suit against you, you will have clear contractual terms you can point to that authorized you to take the actions you did.

You can also use a shareholder agreement to make sure that the company always has the option of buying out the shareholder’s interest if they decide to sell. This type of provision, called a Shareholder Buyout Agreement, can help you to prohibit a hostile entity from gaining shares – and thus voting rights – in your company.

You can also include important clauses such as non-compete provisions in your agreement in order to ensure that shareholders don’t use information they gathered about your company to directly compete with it once they leave.

While it may be tempting to start up your company as cheaply and simply as possible, there are certain expenses that you simply should not forego. Crafting an adequate shareholder agreement can make all the difference in your company’s viability down the road.