Why You Need a Shareholders Agreement (Part I)

Why You Need a Shareholders Agreement (Part I)

If you are forming a corporation with a partner, regardless of whether it is with your best friend that you have known since birth or a new business relationship, executing a well-crafted Shareholders Agreement is essential.  Too often, partners mistakenly believe that the corporate By Laws answer all the questions and will adequately set the parameters for the relationship between shareholders.  While the By-laws address day-to-day operations of the corporation, the Shareholder Agreement is where a number of specific rights and obligations of the shareholders are set forth.  Common provisions of a Shareholders Agreement will address such issues as voting rights, restrictions on voluntary and involuntary transfers of stock, buy-out clause, non-competition obligations, death, incapacity or divorce of a shareholder, and limitations on Board of Directors powers.  The next several posts will address the importance of the Shareholders Agreement, some of the common provisions, as well as several issues that are often overlooked in drafting the Agreement.

1.  Do Not Confuse the Articles, By-laws and Shareholders Agreement.

Entrepreneurs forming a corporation for the first time may find that they are unclear as to the differences between the Certificate of Incorporation (or Articles of Incorporation), By-laws and the Shareholders Agreement:

    A. Certificate of Incorporation:  This document (which often have a different name outside of New York, such as Articles of Incorporation), is the only document that must be filed in New York to form a corporation.  As with many states, New York provides a simple form requiring only limited information to be included in the Certificate (name of the entity, purpose, county where located, number of authorized shares, and name of registered agent).  While you may draft your own form, the simple New York form is all that is required to incorporate.  There are siutations where you might draft your own Certificate of Incorporation, as where there are different classes stock, and the Certificate of Incorporation will be more complex.  However, the basic Certificate of Incorporation is a bare-bones document that does not address any issues relating to corporate governance, authority of the Board of Directors, or the rights and obligations of the shareholders.

  B.  By-laws of a Corporation.  The By-laws serve the purpose of setting forth important terms relating to the governance of the corporation.  Thus, the By-laws establish important aspects for day-to-day operation of the corporation:

            (i) Board of Directors:  the number of members of the Board of Directors, meetings of the Board, voting, removal, vacancies, and powers of the Board of Directors;
 
            (ii) Shareholders:  Annual and Special Meetings of Shareholders, including notice, voting, and general procedures;

           (iii)  Officers:   election/appointment and removal procedures and authority of officers;

           (iv)  Indemnification:  indemnification of Directors, officers, employees of the corporation; and
   
          (v)   Miscellaneous:  Stock, Maintaining Books and Records, Seal of the Corporation, Amendments to the By Laws.        

    C.  The Shareholders Agreement.  The Shareholders Agreement  is the document among the Shareholders and the Corporation where a number of specific rights and obligations of the shareholders and the corporation are detailed.  The Shareholder Agreement is a contract, and can include essentially any terms that do not violate the New York Business Corporation Law (or any other applicable law).  Typical provisions can include voting agreements or rights among the shareholders, restrictions on voluntary transfers of stock (i.e., selling stock to a third-party) and involuntary transfers (death, bankruptcy or divorce of a shareholder), a buy-out clause, non-competition obligations, information rights of shareholders, and limitations on authority of the Board of Directors and dispute mechanisms.

2.  Why the Shareholder Agreement is Essential.

The Shareholder Agreement is essential as it clarifies the rights and obligations of the Shareholders between each other as well as certain obligations of the corporation to the shareholders that are not otherwise included in the By-laws.  Too often entrepreneurs, to their peril, are willing to rely on the relationship with their friend (now business partner) or believe they lack the negotiating position to ask for certain rights as a condition of an investment or becoming a minority partner in a business.  A well-drafted Shareholders Agreement not only helps delineate the rights of the business partners, but it will in most cases resolve any disputes before they arise because the issue will have been addressed in the Agreement.

Below are some typical disputes that will be alleviated with a Shareholders Agreement:

  • Deadlock in a 50/50 corporation
  • The sale of shares by your business partner to his undesirable friend
  • The transfer of shares to the free-loading son of your deceased business partner
  • The transfer of shares to your business partner's spouse in a divorce
  • A decision by the Board to hire an employee at a ridiculously high salary         
If the business partners have a Shareholders Agreement, all of the above can be dealt with before they become issues.
 
3.  What are some of the Key Provisions to Include in a Shareholders Agreement?

Important provisions in a Shareholder Agreement will, at a minimum, include:

    A.  Restrictions on voluntary and involuntary transfers of a shareholder's stock;

            (i) Right of First Refusal
            (ii) Co-Sale (Tag Along) Rights
                                               
    B.   Resolution mechanism/buy-out clause in case of a deadlock;
   
    C.   Voting rights and obligations among shareholders;
   
    D.   Limitations on Board of Directors powers; and
   
    E.   Several Miscellaneous Rights

           (i) Restrictive Covenants
           (ii) Drag-Along Obligations in the event of sale of the company
           (iii) Information Rights

The next several posts will discuss the above typical clauses of a Shareholders Agreement, including important drafting tips.



Disclaimer:  The discussions in this Blog do not constitute legal advice nor create an attorney-client relationship.  You are urged to seek the advise of an experienced lawyer who can provide counsel with respect to your corporate/business law matters

Views: 21

Comment

You need to be a member of 516Ads Custom Internet Page to add comments!

Join 516Ads Custom Internet Page

Members

Latest Activity

David Gussin posted a blog post

516Ads/ 631Ads (718Ads)... October 2017 Dates

516Ads/ 631Ads (718Ads)...October 2017 Dates October 2, 2017 8AM @ Panera NassauOctober 3, 2017 12PM @…See More
8 hours ago
David Gussin posted an event

516Ads/ 631Ads - Panera Suffolk Business Breakfast at Panera Bread 1025 West Montauk Highway, West Babylon NY

September 28, 2017 from 8am to 10am
516Ads.com & 631Ads.com Panera Suffolk Business Breakfast Thursday, September 28, 2017  8AM - 10AM @ Panera Bread - 1025…See More
8 hours ago
Jean bertini and David Gussin are now friends
9 hours ago
David Gussin shared a profile on Facebook
19 hours ago
NCAN - Neuroendocrine Cancer AN posted a status
"Make a difference in the lives of neuroendocrine cancer patients. LI Zebra Walk 10/21 Eisenhower Park. https://goo.gl/zhL7k3"
21 hours ago
Profile IconPower Washing Dragon and Paint, AlaTurca Mediterranean Rest, The Sexy Salad and 1 more joined 516Ads Custom Internet Page
Wednesday
David Gussin shared Graham Intl Consulting, Research's event on Facebook
Tuesday
Graham Intl Consulting, Research posted an event
Thumbnail

KEOS Bayside at 4732 Bell Blvd, Bayside, NY 11361

October 18, 2017 from 6pm to 7:30pm
Limited Space. Register Here!!! KEOS BaysideKEY ELEMENTS OF SUCCESSI.                    Defining the mental process of Methodical FOCUS…See More
Sunday
Graham Intl Consulting, Research updated their profile
Sunday
Graham Intl Consulting, Research posted a photo

Dr. G. GRAHAM International

Dr. Graham is a highly accomplished speaker, trainer, mentor, researcher and management consultant to small and start-up businesses. Dr. Graham of GRAHAM International Consulting and Research (GICaR), is a small business specialist with nearly two…
Sunday
David Gussin posted blog posts
Sep 16
Gus's Driving Lessons commented on 516 Ads's group Networking
"If you want to pass your road test, give Gus's Driving Lessons a call (516) 451.1097"
Sep 16

© 2017   Created by 516 Ads.   Powered by

Badges  |  Report an Issue  |  Terms of Service