The Shareholders Agreement Explained for Small Businesses
Common Sections and Terms to Know
The shareholders—sometimes called stockholders—of a corporation are those who own one or more shares of stock in the corporation. A shareholders agreement is an agreement between the owners of the business, with the business as a whole, and with each other.
A shareholders agreement is similar to a partnership agreement or an LLC operating agreement—all of these documents are agreements between owners. But the shareholders agreement doesn’t detail the operations of the company. The bylaws of a corporation describe the duties and responsibilities of the board of directors in their role of overseeing the corporation activities. The shareholders agreement is just between the shareholders.
Why Does My Business Need a Shareholders Agreement?
Every corporation that has shareholders needs a shareholders agreement. Even if your corporation is private (not selling shares to the public) and closely held with only a few shareholders, it’s important to have an agreement. In fact, small private corporations often use these agreements more than large public companies.
A shareholders agreement focuses on the voting of shares of stock, and restrictions and safeguards on these shares. Its purpose is to set out the rights, duties, and obligations of both the company and the shareholders and their relationship.
The agreement gives corporations a way to:
- Control voting and ownership of the company
- Set a method for settling disputes
- Describe a way to accept future capital contributions by new owners
How Does a Shareholders Agreement Work?
Shareholders agreements are governed by state laws, but federal laws—specifically regulations by the Securities and Exchange Commission (SEC)—are involved because shares are securities, especially shares available to the public.
Shareholders agreements are legally binding contracts and they should be prepared by an attorney to be sure they comply with state laws and can be taken to court.
These agreements are internal documents, for use within the company. You should keep a copy of this agreement on file in your corporate office with your other corporate records.
What’s Included in a Shareholders Agreement?
There are various sections included in a shareholders agreement, though they may differ slightly from company to company.
Description of the Parties
The first section of the agreement should specify and identify the corporation as one party and the “shareholders” as the other party.
Recitals or “Whereas” Clauses
The term whereas means something to consider or “that being the case.” For example, a whereas clause in a shareholders agreement might state that the parties want to document their mutual understanding.
The Board of Directors
This section describes in general how the board of directors of a corporation works, including the requirement that the decisions of the board must have a majority. It also may describe how directors are to be replaced.
Company Management and Operation
How directors and board officers are elected also should be outlined in the agreement. This describes actions that shareholders may vote on and whether a majority or a two-thirds majority is required. For example, the shareholders might vote on:
- Declaring a dividend
- Dissolving the company
- Entering into bankruptcy
- Changing the business of the company
Actions Involving Shares
Shareholder agreements contain the rights of shareholders to hold, sell, or transfer their shares. For example, this section might include restrictions on what happens to shares in the event of the death of the shareholder. Another important subsection may outline what happens if shares are transferred involuntarily (as a result of a shareholder’s bankruptcy, for example).
Information and Meetings
The agreement should state that shareholders are entitled to periodic (usually quarterly) reports and an annual report. The date and time of this annual meeting may also be specified.
Conflict of Interest
The right of a shareholder to have an interest in an outside business may be stated in the agreement.
Outside of the shareholders agreement, corporate board members usually must sign a conflict of interest policy statement.
Effect of Noncompliance
If a shareholder doesn’t comply with the agreement, they may be removed as a shareholder and any transfers they make would be null and void.
Amendment and Termination
The process for amending the shareholders agreement is described here, and the events causing termination are listed. The agreement might terminate on a written agreement, the dissolution of the company, or a specific number of years after the initial date of the agreement.
Shareholders agreements, like other contracts, are subject to state laws. The agreement should include a statement that it is to be governed and enforced according to the laws of whichever state is needed.
Waiver of Jury Trial/Arbitration
The shareholders agreement might include a section stating that the parties agree to waive a jury trial and to settle all disputes with arbitration. The arbitration process should be discussed in detail and may in its own subsection.
The agreement allows for transfers to other parties, but they must first acknowledge the terms of the agreement. After signing the statement, the new party is considered a shareholder for the purpose of the agreement.
These are just some of the general sections that are often included in shareholders agreements. There may be more or less information that you need to outline in the agreement depending on your business. The important part is that the shareholders agreement is comprehensive and detailed enough so that all parties involved clearly understand their role. A lawyer can help you create one that’s right for your business.