Founders of closely-held
businesses are generally enthusiastic about their business' prospects and
allied in the common cause of building a success story. They are often reluctant to think about what
happens if later their visions diverge, personal relationships sour, financial
situations decline or health deteriorates.
An agreement for managing these situations, such as a shareholders
agreement[1],
is essential to minimizing the damage to both the company and the individual
relationships. Generally, the sooner
this agreement is entered into the better.
If you have a third-party financing source, they may well require a
shareholders agreement.
In a closely-held corporation,
there are a small number of shareholders
who are very often also directors, employees and/or creditors of the
corporation, and may well be related to one another. One shareholder may put in cash or property,
and another may contribute sweat equity.
These multiple and differing relationships create significant potential
for conflict among the shareholders.
Shareholders agreements are designed to provide solutions to these
conflicts before they occur. In
addition, the process of a preparing a shareholder agreement will hopefully
flush out any significant differences in business philosophy or personal goals
while there is little at stake and everyone is still pulling together, instead
of later when there is more to lose and the relationships may have become
adversarial.
A shareholders agreement will
typically do one or more of the following, with some tailoring to suit the
particular company:
·
Restrictions on Transfer.
Restrict transfer of the shares in order to prevent a new shareholder
from participating in the venture without the approval of the original
shareholders, although transfers to family members and their trusts are
generally allowed.
·
Transition and Liquidity. Provide liquidity for the estate of a
deceased shareholder, by requiring the company or the surviving shareholders to
buy back the deceased's stock.
·
Buy/Sell.
Establish procedures (such as
rights of first refusal, mandatory repurchases, puts or calls), through which the corporation or the other
shareholders may purchase the stock of a shareholder who, for example, is no
longer employed by the corporation, is deceased, disabled, divorced, retired,
declares bankruptcy, or desires to sell.
·
Valuation.
Provide a mechanism to set the price of stock being bought by the
corporation or other shareholders, or for estate tax purposes. The price can be
pegged to book value, a multiple of earnings value, an appraised value, by
agreement, or by some combination of these mechanisms.
·
Payment Terms.
Specify the payment method, such as cash or an installment note over a
term of years, if the corporation or other shareholders purchases a
shareholder's stock. Collateral or
personal guarantees from the other shareholders may be required.
·
Key Man Insurance.
Provide for the purchase of key man insurance to fund the corporation's
repurchase of a deceased shareholder's stock.
·
Control.
Maintain the founding shareholders' respective ownership percentages by
granting them a first right to purchase stock (preemptive rights), if the
company offers stock for sale in the future.
·
Corporate Governance. Establish basic corporate
policies regarding matters such as the payment of dividends, election of
officers and directors, establishment of voting groups, and sale of the
company.
·
Subchapter S Corporations. Prohibit the shareholders from
transferring their stock to persons that would cause the corporation to be
disqualified from Subchapter S status; provide for distributions sufficient to
pay any taxes passed through to the shareholders; and provide for unanimous
shareholder consent to termination of Subchapter S status.
None of these issues are
adequately addressed in corporate statutes or organizational documents, if at
all. Without at least a basic
shareholders agreement, significant changes in the relationships between the
shareholders and the company may cause distracting controversy and, at worst,
may threaten the existence of the company.
If your company has more than one shareholder, regardless of whether the
company is newly formed or already existing, a shareholders agreement can be a
powerful tool for navigating the company's future.
[1] While this article discusses the possible
provisions of a shareholders agreement between a corporation and each of its
shareholders, each of the concepts can be applied, with appropriate
modification, to limited liability companies or partnerships.
By Eugenie Rivers, a Bellevue Business Attorney and Bellevue Securities Attorney with Rivers Business Law.
By Eugenie Rivers, a Bellevue Business Attorney and Bellevue Securities Attorney with Rivers Business Law.
