When contemplating a collaboration with others, it is crucial to carefully weigh both the potential risks and benefits involved.
As professionals practicing business law, we often receive inquiries from clients seeking ways to mitigate risks in a business partnership. Amid the eagerness to launch a new startup, the answer to this inquiry can be easily overlooked.
The truth is, if you wish to avoid extensive legal complications in the event of a fallout with your business partners, considering a shareholders’ agreement is essential.
What Is a Shareholders’ Agreement?
In simple terms, a shareholders’ agreement is a contract between the owners of a company that governs their rights and obligations in various situations related to the company’s ownership and operations. Let’s delve into some key aspects that a shareholders’ agreement addresses and how it can safeguard your interests.
Defining Shareholders’ Responsibilities and Expectations
When starting a potentially groundbreaking company with a business partner, enthusiasm and motivation are likely to be high. However, it is essential to ensure that both partners are equally committed to contributing the necessary “sweat equity” as challenges arise and successes are scarce.
A shareholders’ agreement serves as a valuable tool in defining the responsibilities and expectations of each partner regarding their work and contributions. This agreement can specify the expected financial contributions over a period and the time and attention each partner must devote to the business. Establishing clear expectations from the outset helps maintain a productive relationship and prevents conflicts that may arise while doing business together. Moreover, the agreement can include provisions for buyout rights if a partner fails to fulfill their obligations.
Restrictive Covenants: Ensuring Confidentiality and Preventing Competition
In a partnership, sensitive and valuable information, such as ideas, plans, and trade secrets, is often shared among partners. Additionally, access to other profitable resources like databases of potential employees or clients becomes available to each shareholder. Unfortunately, there’s a risk that these resources might be misused for personal benefit or to set up a competing business.
To minimize these risks, restrictive covenants are standard provisions in a shareholders’ agreement. These covenants impose certain restrictions on shareholders to prevent the improper use of company resources or competition with the company. Typically, these include confidentiality, non-compete, and non-solicitation clauses. Confidentiality clauses ensure that shareholders do not disclose or use proprietary information for personal gain. Non-compete clauses restrict shareholders from engaging in competitive activities during a specific time and within a certain geographic area. Non-solicitation clauses prevent shareholders from poaching customers and employees of the business for their personal ventures.
Decision-Making Process
When multiple individuals run a company, decision-making authority is shared. To avoid conflicts and streamline the process, the shareholders’ agreement can define the scope of authority for each partner and set thresholds for significant decisions.
The agreement might outline areas where partners can make decisions without consulting others, as well as matters requiring agreement from all or a certain percentage of partners. It can also grant more decision-making power to shareholders who contributed more financial capital, though it may also advocate equal decision-making regardless of financial contributions or based on other critical factors. Additionally, minority shareholders may receive protections, ensuring that certain decisions require unanimous consent from all shareholders, regardless of their share ownership.
Contingencies and the Sale of Shares
Even in harmonious partnerships, unexpected events such as death, disability, or divorce of a shareholder can significantly impact the stability of the company and individual financial interests.
A well-drafted shareholders’ agreement should address these contingencies. Typically, the agreement includes provisions allowing shareholders to buy the shares of another shareholder in such circumstances. For example, in the event of a shareholder’s death, the agreement may grant surviving shareholders the option to purchase the deceased’s shares, preventing unrelated parties from gaining influence in the company.
Divorce Provisions: The Shotgun Clause
Similar to marriage contracts, shareholders’ agreements can include provisions to address potential dissolutions of business partnerships. When disagreements between shareholders become irreconcilable, a viable solution might involve one shareholder leaving the company.
A notable provision in such cases is the shotgun clause, which grants a shareholder the right to make an offer to buy or sell their shares, along with setting the price and terms of the transaction. The other shareholder then has the choice to either buy the shares at the specified terms or sell their shares under the same conditions. While the process might seem drastic, the shotgun clause can be an effective way of settling irreconcilable differences.
Getting Your Own Shareholders’ Agreement
When considering the creation of a shareholders’ agreement with your business partner or partners, remember that it is not a do-it-yourself endeavor. Businesses and shareholders have diverse needs, and the agreement must adequately reflect those needs while providing proper protection.
To ensure your shareholders’ agreement meets your requirements and safeguards your interests, it is best to seek the advice of an experienced lawyer. CBES is here to assist you; feel free to contact us for expert guidance.