Important Shareholder Agreement Clauses
Any good shareholder agreement must protect the interests of the shareholders that are party to the agreement with shareholder agreement clauses. Looking ahead to probable and improbable scenarios, such as the death of a major shareholder, conflict regarding operations, divorce or disability of a shareholder, or decisions regarding when to issue new shares can all lead to conflict if not addressed from the outset with clauses that spell out how these situations will be addressed and resolved.
Below you will find the most important clauses to include in a shareholders agreement. Of course, shareholder agreements and the clauses that you choose to include should address the particular needs and vision of the particular corporation. A qualified lawyer with experience in drafting shareholder agreements should be consulted to make sure that your rights as a shareholder are protected while ensuring that the growth and value of the corporation continue to increase.
- Right of First refusal
Right of first refusal allows shareholders to buy the shares another shareholder would like to sell first before the shares are sold to outside third parties. However, if the shareholders cannot afford the shares, they may be sold to third parties. This allows shareholders to retain their percentage and protects them from unwelcome shareholders. However, this may cause delays in the sale of shares and discourage institutional investors from investing because they will have smaller proportional shares
2. Pre-emptive rights
Similar to a ROFR, pre-emptive rights protect the rights of shareholders in cases where the corporation decides to sell newly issued shares from treasury to a third party. This will allow shareholders to buy shares before they are sold to third parties and consequently retain their percentage share in the corporation. The disadvantage is that this may delay the sale of the shares and discourage institutional investors from investing in the company because they may get a smaller proportionate share
3. Piggyback rights
Piggyback rights, also known as “tag-along” rights protects minority shareholders in the event of a third party buyout of a majority shareholder’s shares. This allows the minority shareholders to sell their shares at the same price and terms if they so choose, effectively piggybacking on the transaction. This protects minority shareholders from being in business with an unwanted new co-owner and from being forced to accept less attractive offers
4. Drag-Along Rights
A drag-along right is the mirror opposite of a piggy-back right; it is a provision that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller. Drag-along rights are designed to protect the majority shareholder
5. Valuation Clause
A valuation clause sets out a method for determining the value of shares. Not being a publicly traded company, which can easily determine the value of its shares, a private corporation is well served to have a valuation clause for a variety of reasons. This clause will set out how the value of the shares will be determined, which will become necessary when shareholders want to sell their shares or when a shareholder dies and the other shareholders want to buy those shares. A valuation clause is key and is primarily intended to avoid disputes at such time as when a shareholder wishes to exit from the business, on retirement or for other reasons
6. Non compete Clause
A non-compete clause refers to situations where one party to the contract agrees to not enter into or start a similar profession or offer the same or similar services in competition against the other party, usually the employer, for a prescribed period of time. A non-comp is fairly standard in a shareholders agreement, effectively preventing the shareholders, officers and directors from setting up a competing company with that of the central business. For a non-comp provision to be enforceable under Canadian law, it must be sufficiently limited in temporal (time) and geographical scope (space)
7. Non-solicitation Clause
A non-solicitation clause prevents shareholders or former shareholders from inducing other shareholders, directors, officers or employees of the corporation to leave the corporation or to compete against it. This clause prevents an influential shareholder from poaching other employees. In contrast to the non-compete clause, the non-solicitation clause does not contain a geographic area or apply to only particular types of products or services. Additionally, non-solicitation provisions do not restrict a former principal of the corporation from working for a competitor, in the way that a non-compete would
8. Shotgun Clause
A “shotgun” clause is a method which enables a party to exit a corporation. It is called a shotgun clause because when you pull the trigger, it could have the effect of killing yourself, so to speak. It works by permitting one shareholder, at any point in time, to offer his shares to the other shareholder(s) at certain price terms. The other shareholders can either agree to sell their shares at that price, or they can buy the offering shareholders shares at that same price. The benefit of the shotgun clause is that it forces a fair and reasonable valuation of shares between the parties, as the offering shareholder will either be paying that price or receiving that price, for the shares. If a shareholder pulls the shotgun and places an offer, the other shareholders can accept it and in turn use that offer to buy the offering shareholder out. The offering shareholder has thus “killed” himself and caused his own exit from the corporation
9. Capital Expenditure Approval
Capital expenditures lock up large sums of money. In a small business, minority shareholders may require that they approve any significant expenditure of capital to protect their investment in the business
10. Management of the Corporation
Specifying issues related to the management and operation of the corporation can be specified in the shareholders’ agreement. If these issues are not specified, then the management of the Corporation will fall on the Board of Directors. Shareholders should decide whether or not they want to take an active role in making vital decisions for the Corporation and include all issues that they deem important to the long -term health of the Corporation.
Directors can be elected in several ways: the majority shareholder can elect the directors or each shareholder can elect a representative director. Alternatively, the shareholders may agree to elect a list of specified directors. All Directors have a duty to act in the best interest of the corporation no matter how they were elected and which group of shareholders they represent. It is advisable to appoint alternate directors should there be a vacancy on the Board of Directors. This way, shareholders can continue to control the appointment of Directors.
Officers of the Corporation can also be elected to maintain consistency in the operation of the corporation. This way, officers will not be subject to termination by new shareholders who may acquire majority share.
Contact Kalfa Law Firm today to help you draft a shareholders agreement that include the critical shareholder clauses necessary to addresses the needs and vision of your corporation. Ensuring the viability of your corporation rests on drafting a shareholders agreement that stands the test of time.
You work hard for your money. We work hard for your to keep it. ™
F.A.Q’s:
-Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law Firm. Shira’s practice is focused in corporate-commercial and tax law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law. Shira graduated from York University achieving the highest academic accolade of Summa Cum Laude in 2012. She graduated from Western Law in 2015, with a specialization in business law. Shira is licensed to practice by the Law Society of Ontario. She is also a member of the Ontario Bar Association, the Canadian Tax Foundation, Women’s Law Association of Ontario, and the Toronto Jewish Law Society.
© Kalfa Law Firm, 2020
The above provides information of a general nature only. This does not constitute legal advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.
