The corporate prenup: Why every corporation needs a shareholders’ agreement

We sat down with Peter Dale, Corporate Lawyer at Caravel Law, to talk about how to put together an ironclad shareholders’ agreement.

No matter what type of shareholder arrangement you have within your corporation (50/50 or majority/minority), it always makes legal and financial sense to have a shareholders’ agreement in place.

These agreements are a proactive way to establish expectations and obligations for shareholders and set terms for corporate management and dispute resolution.

However, there are no requirements under corporate statutes in Canada for corporations to have a shareholders’ agreement. This means many companies don’t have one, which sets-up the business for potential pitfalls down the road.

But even if you don’t have a shareholders’ agreement in place – it’s never too late to have one drafted. So how do you put together an agreement that will protect your interests and the organization’s long-term success?

It all depends on which type of shareholder you are.

If you’re a majority shareholder

If you’re a majority shareholder, you are in the driver’s seat. So this agreement is about strategically managing your minority shareholders and establishing clear expectations concerning their rights and your obligations.

A shareholders’ agreement will help prevent a mismatch of expectations from the start and clearly define what you are prepared to provide and offer your shareholders. If you want to have complete voting control within the corporation, you should explain that clearly in the agreement.

Once you’ve drafted the terms of the agreement, you’ll want to present it to shareholders and potential investors and clearly explain that this is the shareholders’ agreement that you require new shareholders to enter into. Depending on how urgently you need their investment, you may compromise on some terms if they want to negotiate.

Once the terms have been agreed, this is the document you and your shareholders must abide by moving forward.

If you’re a minority shareholder

If you’re in a minority shareholder position, the shareholders’ agreement will be essential to you, and you’ll want to ensure any company you choose to invest in has a shareholders’ agreement in place before you get involved.

Without a shareholders’ agreement, it’s often challenging to realize the value of, or monetize, your shareholding. It also means that, except for pursuing certain statutory rights, which may be an expensive process, you have little legal recourse if things go wrong and you feel you aren’t being treated fairly.

As a minority shareholder, this agreement will help define your entitlements and provide remedies if other shareholders fail to abide by the terms of the shareholders’ agreement.

So what should a well-drafted agreement include for minority shareholders? Here are some must-haves:

  • Adoption of an annual business plan that sets out caps on management fees and other expenses and establishes working capital requirements/limits
  • An obligation for the company to distribute profits (above working capital requirements set out in the annual business plan)
  • A supermajority (i.e. the majority shareholder + additional shareholders) for extraordinary items such as, for example, amending the annual business plan
  • A first-right-of-refusal on newly issued shares
  • Terms that define how shares can be bought or sold
  • Terms that define how new investment is taken in and additional shares are issued
  • Terms that define how corporate debt is taken on

The first two points are the most important for a minority shareholder from a financial perspective. In the absence of a clearly defined mechanism governing how the company manages its profits, that money can often be mysteriously consumed in management fees and the company’s operations.

This means even if a company is successful, without these terms set out in an agreement, a minority shareholder might not ever profit from their investment.

If you’re a 50% shareholder

If the saying goes that 50% of marriages end in divorce, it stands to reason a good percentage of businesses might not make it either. This is why a shareholders’ agreement in a 50/50 shareholder partnership is often referred to as a ‘corporate prenup.’

While some may think a marital prenup is not particularly romantic, the same can’t be said when it comes to a business partnership. In this case, each party should approach the agreement as a way to protect their financial interests and the long-term success of the company.

The biggest challenge in a 50/50 partnership is that each shareholder has equal voting power, which often ends in a stalemate.

We’ve seen many situations where viable, profitable companies fail due to a disagreement between two equal-founding shareholders. Not dissimilar to an acrimonious divorce, these long, drawn-out battles can result in high legal fees that consume whatever capital and value is in the company.

In this scenario, a shareholders’ agreement can help establish and set out what the reciprocal expectations and obligations are of each shareholder. Critically, it should also include a framework and process for negotiations, arbitration, and dispute resolution, as well as a sale mechanism if the disagreement cannot be resolved.

This sale mechanism should outline how you’re going to value the company, who will appraise it, and the timeframe in which you are required to sell. This also means considering shotgun, tagalong or drag-along clauses within your agreement.

Need support drafting a shareholders’ agreement for your corporation or reviewing one for a company in which you’re contemplating investing? Caravel Law is an alternative legal firm with over 50 qualified and experienced lawyers to help support your legal needs. Get in touch with our team today to find out more.

The information provided in this article is not intended to be legal advice. Many factors unknown to us may affect the applicability of this content to your particular circumstances.

  • Share:

Work with a law firm that gives your business the attention it deserves.

Contact us