Shareholders agreements are an important part of any business, big or small, that has more than one shareholder. Shareholders agreements exist to establish the rights and responsibilities of shareholders in the business. They are not compulsory in Massachusetts, but are highly advisable whenever a new business is set up to avoid contradictions, confusion, disagreements and disputes that might arise from time to time or when shareholders acquire, transfer or sell shares.
Type of business for which shareholders agreements are designed
All corporations and Limited Liability Companies (LLCs) and any other smaller business which has more than one shareholder should have a shareholders’ agreement. Without a shareholders’ agreement the business is dependent on the state’s own rules that apply to the governance of companies. In Massachusetts, the Massachusetts Business Corporations Act, which became effective in 2004, outlines amongst a lot of other legislation relevant to corporations, the state’s rules concerning shareholders’ meetings and agreements. The relevant sections of the Act can form the basis for establishing a written shareholders agreement which is compiled specifically to address the needs of the particular business.
What aspects of a business do shareholders agreements address?
Decision making over transfer of shares
While the sale of shares in a corporation or LLC is generally left to the decisions of individual shareholders, this might not be the case in a privately owned business in which the shareholders are known to each other. A shareholders agreement may allow non-selling shareholders the right to decide whether a shareholder who wishes to transfer their shares to a third party should be allowed to do so. The point of this is to ensure that remaining shareholders agree who they want to remain in business with.
Provision for an exit strategy
A shareholders agreement should provide the means by which an existing shareholder can sell or transfer their shares in the event that they no longer wish to participate in the business.
Decision making
Each business will have a mechanism for making decisions. In most corporations this is in the form of a board of directors, while a LLC is more likely to appoint managers to make decisions about the running of the business. However, there may be important decisions which shareholders may wish not to be made solely by a board of directors or managers. The shareholders agreement should set out the conditions or issues which would entail approval by the shareholders. This might include such things as:
- sale of the business;
- purchasing property;
- borrowing money;
- pursuit or settling of litigation.
The shareholders agreement, then, restricts the decision making power of the directors or managers and provides protection for shareholders against adverse action by others.
Protection for minority shareholders
In most businesses, voting is based on share ownership, so those with more shares have a greater voting power. Without some protection for minority shareholders this could lead to a situation in which those with fewer shares may find that decisions are made by majority shareholders that they do not agree with. A shareholders agreement may have a provision in it that requires unanimous approval of particular issues.
Protection for majority shareholders
In addition to protecting minority shareholders there are also certain situations in which a minority shareholder or shareholders could prevent or obstruct a decision which could be to the detriment of the majority shareholders. For example, if it has been decided that it is in the best interests of the business to sell it, majority shareholders may be given the right in a shareholders agreement to force any obstructing minority shareholder to sell their shares at the same time in order to allow the sale of the business to proceed.
Dispute resolution
Shareholders agreements can prevent disputes and conflicts becoming costly and damaging by providing a pathway to resolve the dispute without having to resort to litigation. For example, a typical resolution pathway may involve an initial informal meeting between disputing shareholders to try and resolve the dispute. If this doesn’t succeed, the next stage may involve mediation and then, again if this does not succeed, arbitration, which would be a final step in the resolution pathway.
Decisions about shares belonging to active owners on employment termination or resignation
A shareholders agreement can establish the terms and conditions that apply whenever a shareholder who is also an employee, manager or director, resigns or exits employment for various reasons, favorable or unfavorable. In many cases, it may allow the shareholder to retain the rights of other shareholders who were not active in the business, i.e. to vote on decisions, enjoy dividends and any other benefits attributed to an increase in the value of the business. However, it may be preferable for remaining shareholders to have the right to purchase the shares of the shareholder whose employment or active association with the business has ended.
Protection of the business’s assets
A shareholders agreement can restrict the potential for harm done to the business by an exiting shareholder who still retains shares in the business from any attempt to disclose confidential information about the business or an attempt to lure the business’s clients or staff away from the business towards a competing business.
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