Shareholder Agreements

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By: LawInfo

Published: 02/2010

Shareholder agreements, also known as stockholder agreements, are important for many businesses but particularly for closely held businesses and family businesses. A shareholder agreement is negotiated and executed before any business problems develop. Shareholder agreements provide businesses with a roadmap of how to act in certain situations. Also, in privately held companies, some shareholder agreements may be kept confidential among the stockholders, unlike the corporate governance documents that must be filed with the state’s Secretary of State’s office.

Stock Ownership Provisions of Shareholder Agreements

The most important issues that are addressed by shareholder agreements are those that address stock ownership. A shareholder agreement can serve two important purposes with regard to stock ownership- it can control when a stock is sold and to whom. For example, in a closely held or family business a shareholder agreement can limit the sale of stock to third parties and it can define triggering events that require a stockholder to sell his or her shares to the other existing shareholders. This is important for a closely held business that only wants specific shareholders and does not want to extend ownership rights to others.

However, some closely knit businesses and family businesses may not want to prevent the transfer of stock to third parties in every situation. Therefore, they may require that an existing stock owner offer other existing stock owners the right of first refusal when selling stock. If the existing owners do not want to purchase the stock then, pursuant to the shareholder agreement, it may be sold to a third party.

A shareholder agreement can also limit a stockholder’s actions after his or her shares are sold. Many shareholder agreements include no competition clauses that prevent a stockholder who sells his or her shares from directly competing with the business for a certain amount of time. In order to be enforceable, this provision must be carefully written so as to allow the selling shareholder a reasonable opportunity to make a living and not unduly restrict economic competition.

Other Provisions of Shareholder Agreements

Shareholder agreements can also contain other important provisions related to the operation of a business. For example, a shareholder agreement can:

· Explain how individual stockholders will be elected to the Board of Directors;

· Require a “super majority” vote among stockholders for certain important votes;

· Describe how future capital contributions will be made to the business and how these contributions may affect ownership rights;

· Create procedures to follow when there is a “tie” vote and the shareholders do not have a majority opinion; and

· Establish conflict resolution procedures to follow if disputes arise among stockholders. This could include mandatory mediation and/or arbitration, for example.

Like all businesses, closely held and family businesses want their businesses to succeed. However, unlike other businesses, they have additional concerns and must take the necessary steps to protect their business from outside control and to protect the rights of different family members. For these reasons, shareholder agreements are particularly important to closely held and family businesses.