Shareholders Agreements: What is their value?

Your New Business Venture

You left your employment to start a new business venture. You are excited to become your own boss. You can visualize how your business will look and run from here forth. Your business and marketing strategies are in pl ace. You have unbounded optimism as to your business’s future success and a tremendous feeling of camaraderie with your partners.

Although you are excited, starting your own com pany is daunting and you are burdened with all of the costs involved. Your budget is limited and you are beginning to realize that your business and marketing strategy will be much more expensive to implement then first ant icipated. In an attempt to reduce costs, and against your lawyer’s advic e, you chose not to complete a shareholders agreement. This can prove to be a very costly business decision.

A Real Life Example

Brown v. Boyar , 2009 BCSC 1300 (CanLII), is an example of the risk taken when starting a business without a shareholders agreement. Brow n and Boyar had a friendship built up over many years of living and working in the community of Whistler, BC. They pursued their dreams of developing land on the shores of Ander son Lake. Their opt imism was unbounded.

At the outset of the business venture Mr. Brow n’s and Mr. Boyar’s intentions were to be equal partners. However, due to the financing arrangement, it was later agreed that Mr. Boyar would take 51% shareholding in the two companies and Mr. Brown a 49% shareholding. Neither Mr. Brown, nor Mr. Boyar obtained legal advice when agreeing to this arrangement. Nor did they execute a shareholders agreement. Initially, the companies were incorporated with both men appointed as directors. However, approximatel y a year later they had a falling out. At the first annual general meeting Mr. Boyar exercised his majority position and voted himself as the sole director of each company. This left Mr. Brown with no managing control.

Subsequently, the business venture failed and Mr. Brown blamed Mr. Boyar for numerous indiscretions in the management of the companies. Had the me n entered into a shareholders agreement, this costly litigation would likely not have occurred.

Benefits of a Shareholders Agreement

A shareholders agreement is an essential document for defining and maintaining the mutually beneficial relationship between the shareholders a nd the company. The company’s Articles and the British Columbia Business Corporations Act ( BCBCA ) provide some protection for shareholders and guidance for the company’s governance. However, the shareholders agreement lets you document your expectations for and obligations to the company. Wi th a lawyer’s help, you can prevent the common pitfalls and disputes that aris e between shareholders.

You have had discussions with your partners and have come to agreement on the business model, the tasks you each will perform for the company, and the general operations of the company. Your current optimism and excitement provide you with c onfidence that future agreements will come with similar ease. However, as the business develops and changes, disagreements as to the management of the company will likely arise between you and your partners. It is at this point the shareholders agreement becomes inva luable. As a result of t he shareholders agreement, a means for dealing with such disputes has already been crea ted. It is important to make decisions early on when the relationship is amicable and parties are willing to negotiate. The following is a list of issues that are commonly addre ssed in a shareholders agreement:

  1. who will manage the business and is there an expectation that each shareholder will be provided a position on the board of directors;
  2. what are the specific dut ies and responsibilities of t he shareholders in running the company;
  3. will the shareholders be entitled to di vidends and how will the amount and frequency be determined;
  4. how will the shareholders capital be invested, w ill the company retain it or use it for its operations;
  5. should shareholders’ relatives be allowed employment with the company or should there be restrictions that limit their involvement;
  6. how will disputes between shareholders be resolved, by an independent party such as an arbitrator;
  7. should a shareholder be able to sell their shares to a person that is not approved by the other shareholders;
  8. what will happen if a shareholde r dies, or gets married, or di vorced, or becomes disabled, as these situations can affect the ownership of that shareholders shares;
  9. if a shareholder wishes to leave the company how will thei r shares be valued and who will purchase them, the company, or the other shareholders, or a person outside of the company;
  10. should there be a means to forced a shareholder to leave the company?

 

If you are a minority shareholder in the business, the shareholders agreement will also provide you with protections from being froz en out by the majority shareholder(s), as was the case in Brown v Boyar . If a majority shareholder is not restricted fr om doing the following, you may find yourself in the same position as Mr. Brown:

  1. can you be forced to sell your shares;
  2. can the majority receive divi dends that are refused to you;
  3. can the company’s earnings be depleted by paying exorbitant salaries and bonuses to majority shareholders;
  4. can substantially all of the company’s assets be sold for less than its worth to a friend or family member of the majority shareholder;
  5. can you be forced out of t he management of the company.

 

The above lists are not exhaustive. Rather, they are a sample of common issues dealt with in a shareholders agreement.

Had Mr. Brown and Mr. Boyar taken the advice of their companies’ lawyer and executed a shareholders agreement Mr. Brown’s managing positi on could have been protected, allowing him to remain as a director of the companies. T he shareholders agreement could have provided Mr. Brown with a means to arbitrate t he dispute, rather than proceed with costly litigation. Further, a shareholders agreement could have provided Mr. Brown with a method for determining the fair value of his interest in the companies and a means for him to exit the business. In short, had the men opted to take the advice of their companies’ lawyer and entered into a shareholders agreement the cost and stress incurred as a result of litigating their dis pute would likely have been avoided.

Will you follow Mr. Brown and Mr. Boyar example; or do you now see the real value in having a shareholders agreement?