Many corporations that form using and incorporation service never realize one of their biggest structural flaws. They are never told that they should have an agreement among the shareholders. The reason for this is that a shareholder agreement requires addressing many issues that incorporation services are not equipped to address.
The bottom line is that if you have more than one shareholder in your corporation, you should almost always have an agreement between you regarding the nature of your shareholdings.
What Does A Shareholder Agreement Do?
A shareholder agreement can address a number of different issues. The most common issue, and indeed the heart of why each corporation should adopt a shareholder agreement, is to set the terms of succession in the event that a shareholder dies, wants to leave the company, or is not meeting the agreed commitments to the corporation and other shareholders.
Some Examples
To illustrate why a shareholder agreement is important, let me paint a fairly common picture. Two friends have a business idea and get together to form a corporation. They each own 50 of the shares. Under the will of the deceased partner, that partner's wife receives all of his assets. This does nothing to help the remaining owner. Honestly, he never really cared much for his partner's wife who is now is co-owner.
Additionally, the wife knows nothing about their business and has her own business that takes all of her time and attention. You can start to see the situation that exists. The reason that the remaining owner is in this situation is that the shareholders did not agree in advance what would occur in this type of situation.
A shareholder agreement should address what happens with the shares when one of the shareholders dies, withdraws from the corporation, becomes disabled, or is not meeting agreed responsibilities. It requires addressing some issues that are not terribly comfortable to deal with in the midst of the positive energy that usually exists when a new business is formed.
Just a few examples of issues that should be:
1. What happens to the shares when a shareholder dies? Can the other shareholders buy out the shares? Can the corporation buy back the shares? Are either required to buy out the shares?
2. What is the value of shares when the shares are repurchased by the corporation or other shareholders?
3. If the corporation is required to buy out a deceased or withdrawing partner, how are the shares valued?
4. What are the performance standards that the shareholders expect from one another and can failure to meet these standards lead to a buyout? If so, what is the value of the buyout and should it be different than valuation upon death?
5. What events should trigger and options or obligatory buyout? Death, disability, non-performance are some of the common triggers.
6. If the corporation is required to buy back shares, how is the buyback financed? coming up with cash or having to borrow money may impede the corporation's capital needs. Should life insurance be used as a way to finance a repurchase triggered by the death of a shareholder?
There are many more issues that a corporation should consider when contemplating a shareholder agreement. The bottom line is that any corporation with more than one shareholder will almost always want to have an agreement between the shareholders and the corporation regarding disposition of shares. These are difficult issues to address because they require dealing with the termination of the relationship between the shareholders at the time that the relationship is just forming. These issues can cause controversy at the point in the life of the business where optimism is crucial. It may be difficult but you will be happy down the road that you confronted these issues early on in the relationship.