Shareholder Agreement

A close corporation usually has the following characteristics:

• A corporation that is owned by a limited number of shareholders (1 - 35)
• Shareholders are generally active in the affairs of the corporation
• There is no ready market for the sale of corporate shares

-The parties to a Shareholder Agreement are the shareholders of the corporation.
-Ideally, all shareholders will participate in the Shareholder Agreement.

This warranty confirms for the shareholders how many shares have been issued and who owns those shares.

-When a shareholder warrants that they are the beneficial owner of their shares, this means that no other person has an interest in those shares nor are they held in trust for someone else.
-This warranty provides additional assurance to other shareholders and creditors regarding who really owns and controls the corporation.

-It is important to have fair representation on the board of directors for both majority shareholders and minority shareholders.
-It should be noted that all directors have a duty to act in the best interest of the corporation no matter how they were elected.

-Specifying the officers of the corporation may prevent subsequent shareholders from firing your officers even if they acquire a majority share or control of the board of directors. This may provide a level of managerial consistency to the company.
-However, for the same reason, specifying the officers may also prevent the company from attracting new investors who want to install their own management team to run the corporation.

-Generally, the directors will make most of the decisions affecting the management of the company.
-However, selecting specific management issues in the Shareholder Agreement preserves the right of the shareholders to maintain control over issues vital to the corporation.
-You should identify all those items over which the shareholders should maintain control.

An auditor is a qualified accountant who performs a systematic examination of the accounting records of a corporation in order to ensure accuracy and compliance with established accounting policies and procedures.

-Financial assistance refers to any gift of money, loan or guarantee of a loan that the corporation might provide to any shareholder, officer, director, or employee.
-This type of assistance would typically be expressly forbidden in the corporate bylaws or in the articles of incorporation. This does not include wages, salaries, benefits, or bonuses.
-This includes shareholders, officers, directors and employees.

-A capital expenditure is money spent to acquire or upgrade physical assets such as buildings and machinery.
-Requiring shareholder approval of large capital expenditures will protect the shareholders' investment from the poor judgment of an officer or employee.
-The amount of the limit will depend upon the size and resources of your corporation as well as the shareholders' confidence in its management.

-A security interest is an interest in corporate property that is granted to a creditor. This is normally used to obtain a loan that the creditor would not be willing to give without some sort of security. A security interest may also be created by an operation of law to ensure the performance of the obligation where a debtor has defaulted on a debt.
-If corporate property is encumbered it means that an interest in the property is granted to another party as security for the fulfillment of some obligation.

A corporate asset is any property owned by the corporation. This includes, but is not limited to, money, real estate, and equipment.

Share redemption is when the corporation purchases its own shares from the market or from a shareholder.

-Issuing shares is where a corporation places shares for sale either on the open market or privately to individuals.
-Corporations will sometimes issue shares for non-monetary considerations when they are trying to attract top level professionals and skilled workers to the corporation or when they are trying to raise capital to purchase property.

-The Shareholder Agreement can end when all shareholders agree to end it, or on a specific date. The option to end it 'by shareholder agreement' should only be used in the following circumstance:

• Where there are a relatively small number of shareholders;
• Where the Corporation is not thinking of taking on new shareholder, and
• Where the shareholders have a good working relationship.

-Even one disgruntled shareholder could cause significant problems for the corporation by refusing to terminate the agreement, even where it would be in the best interest of the corporation to do so.
-If there are a relatively large number of shareholders, or where the corporation is trying to increase the number of shareholders, or if the potential exists for conflict among the shareholders, then the Shareholder Agreement should have a specific end date.

-When a shareholder purchases shares, the shareholder increases their equity in the company.
-When a shareholder makes a Shareholder Loan to the company, it is a personal debt owed to the shareholder by the company, as though both were private individuals. That debt must be repaid, but it does not increase the shareholder's equity in the company.

-Pre-emptive rights give existing shareholders the right to buy any newly issued shares from the corporation before shares are offered to outside (third) parties. This protects existing shareholders by allowing them to retain their percentage of ownership in the company.
-Disadvantages of pre-emptive rights are that they may cause long delays in the sale of shares, and that they may discourage sophisticated institutional investors from investing because the third party investors may get a smaller proportionate share of the corporation than they might want if the pre-emptive rights are exercised.

-A valuation clause provides a method to determine the value of the corporation's shares. This process will be needed when a shareholder wants to sell his or her shares or when a shareholder dies and the other shareholders want to buy those shares.
-Since most small corporations are private (not traded on a public stock exchange), the share value can be hard to determine without a predetermined method. Having this clause will reduce the uncertainty and disagreements that can occur.

-Shares that are not publicly traded on a stock market are hard to valuate because they are not easily convertible to cash.
-Valuating the shares yourself may lead to a large over-or-under valuation. Either mistake can be detrimental to the company and to all affected shareholders.
-A professional will give a more accurate valuation that is fair to all shareholders. However, you must consider the additional expense of a professional valuator.

-A non-compete clause prohibits shareholders from competing with the corporation while they are owners in the corporation and for a short period after they have left the corporation.
-In a small corporation, customers deal closely with the shareholder. A non-compete clause prevents an influential shareholder or former shareholder from attracting customers away from the corporation.
-A shareholder that leaves the corporation may also possess confidential information that can be used to compete against the corporation.

-A non-solicitation clause prevents shareholders or former shareholders from inducing other shareholders, directors, officers or employees to leave the corporation or to compete against it.
-This clause prevents an influential shareholder from stealing key employees.

-Mediation is a process by which a neutral third party, the mediator, assists the conflicting parties in negotiating an agreement regarding the issue in conflict.
-Arbitration is a process by which the conflicting parties present their conflict to a neutral third party who decides on how to resolve the issue.

-A mediator or arbitrator should be used when the parties are at a deadlock over an issue. Mediation and arbitration are superior processes when there is a long term relationship involved and the survival of the business relationship is desirable.
-If the dispute is not resolved and goes to court, a judge may decide on a compromise that is not desirable to either party, possibly to dissolve the company. But, if both parties agree to choose a neutral third party mediator or arbitrator to resolve the dispute, the business relationship may be able to continue successfully.

-A shotgun clause provides an escape mechanism for shareholders if there is a serious dispute that cannot be resolved.
-In a shotgun provision, one shareholder may offer to buy the other shareholder's shares for a certain price. A shotgun clause stipulates that the other shareholder may either sell his/her shares at that price, or buy the offering shareholder's shares at that same price. This process provides incentive for the offering shareholder to name a fair price.
-However, if shareholders have unequal financial resources or if one shareholder would not be able to manage the company by his or herself, one shareholder could be at an advantage and offer an unfairly low price. For that reason, the shotgun clause favours shareholders with stronger financial resources, and greater ability to run the company by his or herself.

-A right of first refusal requires that when an existing shareholder wants to sell his shares, all shares must first be offered to existing shareholders on a pro rata basis.
-A right of first refusal allows the existing shareholders to retain their percentage stake in the corporation. It also helps protect existing shareholders from unwelcome new shareholders.
-If the existing shareholders cannot afford to buy the shares, the shares may still be sold to the third party.

-A tag-along clause (also called "piggyback" rights) protects minority shareholders in the event of a third party buyout.
-If a majority shareholder sells his/her shares to a third party, the minority shareholder will have the right to become part of the transaction and sell his/her shares to the same third party purchaser at the same price and on similar terms.
-Thus, the third party, if they wish to purchase the shares, must be prepared to purchase ALL of the outstanding shares.