The Law Office of Hutchinson, Thompson, Henderson & Mott

Shareholder Agreements

November 12th, 2013

By: Nathan Green

 

Most of the documents produced by lawyers are ones you hope to never use.  A Shareholder’s Agreement is a perfect example of this.  Everyone’s hope, when the document is made, is that it is never needed.  But when it is needed it will be worth ten, a hundred, or a thousand times the cost of making it.  Further it is often the case that the mere existence of a Shareholders Agreement prevents problems even though the agreement itself is never invoked.

 

A Shareholders Agreement sets out, in advance, how certain situations between shareholders are to be resolved.  Because its goal is getting ahead of problems that might develop there is no such thing as a simple Shareholders Agreement, and in fact the shorter the document the more limited the situations it covers and the less protection it provides.  A well-crafted Shareholders Agreement provides for a number of specific situations typically encountered by businesses and has a number of general provisions that, depending on the severity of the event the corporation encounters, provide for a variety of possible responses.

Let’s consider two examples:

First – a situation that is becoming increasingly common – a business has gone along well for many years but one partner wants to retire and divest him or herself from the business.  Even good friends and long time partners can find themselves in a major disagreement about how to value or pay out the company.  A Shareholders Agreement can set out fair terms for how this could happen.  When both partners are looking at something that will happen in the future and considering how to keep everyone happy so the business continues to thrive in the years ahead.  It is much easier to determine what is fair before one partner wants to leave rather than at the last minute when the question is how much.

 

Second – historically the most common concern in Shareholder Agreements – is when partners have a falling out.  A business may be going very well for years or decades but personality conflicts or differing visions for the business can slowly eat away at what was a very good relationship.  This can particularly be the case where a very successful business has a few bad years and change is needed.  Shareholder Agreements can provide for a number of possible options.  The two most common however are what is known as shot-gun clauses, and forced sale clauses.  A shot-gun clause essentially says that if either partner is unhappy they set a price and the other partner is forced to pick: buy the other’s shares at that price or sell them your shares at that price.  It is the equivalent of “one cuts the other chooses”.  The other typical option – a forced sale – allows one partner to demand the other buys them out at a price set by an appraisal.  If you were a 10% shareholder in a business with Donald Trump you wouldn’t want him to be able to say that you can either sell him your 10 shares for 100K (when you think they are worth 200K), or buy his shares for 9 million dollars (even though you think his interest is worth 18 million you won’t be able to get the money to buy).  However if you start a small business with a financially equivalent friend you might not want him to be able to demand you pay him the fair market value of his shares should he want out of the business (you might not have the money for an appraisal let alone buying him out so a shotgun where you can chose to be bought out might be best).

 

 

There are literally dozens of other key provisions in Shareholder Agreements ranging from what to do if a shareholder cannot be reached and key documents need to be executed, to the authority of officers and directors to act without consulting the shareholders.  It is a key document for any corporation where there is more than one shareholder – especially when changes, such as retirement, start to appear on the horizon.