Why you Need a Shareholder’s Agreement for your Small Business

With a startup budget, you don’t want to spend money on legal documents you don’t need for your business. Having said that, it’s important to consider which agreements you need in place for your particular business to protect yourself if other shareholder’s want to exit the business. First and foremost, you need to know what a shareholder’s agreement is.

What is a shareholder’s agreement?

A shareholder’s agreement is an agreement between individuals who hold shares for the same corporation.  A shareholder’s agreement establishes the rights of majority and minority shareholders of the corporation while also establishing the responsibilities of the board of directors and officers for that corporation.  It is beneficial to have in place when the corporation only has a few shareholders.

A shareholder’s agreement is not filed with any governing body and is similar to any other business agreement.  The document is typically kept within your corporation’s minute book.

When is a shareholder’s agreement not necessary?

You don’t need a shareholder’s agreement if you are the sole director and shareholder of your business.  A shareholder’s agreement is an agreement among multiple shareholders of a corporation.  If you operate a business on your own and have chosen to incorporate, you don’t need a shareholder’s agreement until you decide to share the ownership of your business by creating and selling some of the shares of your business to another person.

Likewise, you don’t need a shareholder’s agreement if you are creating a not-for-profit corporation.  Shareholder’s agreements are meant for corporations that are generating a profit.  For federally incorporated not-for-profit corporations, non-soliciting corporations can enter into a “unanimous members agreement” (UMA) which is similar in function to that of a unanimous shareholder’s agreement for private corporations.  A UMA allows the members of non-soliciting corporations that are federally incorporated under the Canada Not-for-profit corporations act (CNCA), to restrict the power of the directors and officers to manage and supervise the affairs of the corporation.  With UMA’s, members can limit the director’s authority to appoint officers, remove a director’s power to make changes to a by-law by resolution and restrict the management authority that a director of the corporation would otherwise have.

What protections does a shareholder’s agreement provide me?

A shareholder’s agreement sets out the rights of existing shareholders when new shares of the corporation are issued of sold.  For example, existing shareholders can have a “right of first refusal” where if an existing shareholder wants to sell their shares in a corporation, these shares are first offered to existing shareholder’s based on their pro rata share before being offered for sale to a third-party buyer.  The benefit of this type of clause is that it protects existing shareholders from co-ownership of the business by a third party.  Similarly, the agreement can also provide for pre-emptive rights for shareholder’s where newly issued shares of a corporation are first offered for purchase to existing shareholders of a corporation.  A shareholder’s agreement can also have “piggyback clauses” where minority shareholders are given the right to sell their shares in a corporation to a third party on similar terms as the majority shareholder.  Similar to a right of first refusal, this clause protects minority shareholders from third-party majority shareholders of a corporation.  The third party must be prepared to buy all of the shares from both the majority and the minority shareholder.  The shareholder’s agreement can also provide shareholders with control over who has ownership of a corporation by giving existing shareholders the authority to approve new shareholders of the corporation.

An often overlooked benefit of a shareholder’s agreement is that it stipulates what happens to the shares of a corporation upon the death of a shareholder.  If a shareholder passes away then their shares are paid into their estate along with their other assets.  These shares are not automatically offered to the other shareholders of the corporation through a right of first refusal.  The beneficiary of the deceased shareholder based on their Will or through intestacy (inheritance rules in the absence of a Will) becomes the new shareholder in the corporation.  A shareholder’s agreement can be used to avoid this outcome by stipulating what happens to shares when a shareholder dies.

Written by Deepa Tailor 

Deepa Tailor is the founder and Managing Director of Mississauga-based, Tailor Law Professional Corporation and a general law practitioner, with vast expertise in a wide variety of cases. Prior to starting her firm, she articled at a full service national Canadian law firm and worked as commercial counsel for a multi-national corporation. Deepa also serves on the board of directors for Many Feathers, a non-profit which focuses on creating local community spaces focused on food security in urban and rural settings across Canada.