The Importance of Shareholders' Agreements in Corporations

Posted by Xochilt Gama on December 19, 2019

SA

So, you formed a corporation to get your business started and have all the formation documents in place. Now what?

The corporate formation process is generally the first step to securing your financial interest and getting your business up and running. Once the corporate formation process has been completed, there are additional corporate documents that many shareholders decide to enter into in order to further protect their financial interest in said corporation.

Generally, the bylaws of a corporation provide the default rules governing how the corporation operates. For instance, the bylaws include provisions as to how directors will be elected, the transferability of shares, how officers will be appointed and removed, and general corporate matters. However, these are the default rules governing the corporation.

For some shareholders, the provisions in the bylaws may be sufficient to ensure that their financial interest in the corporation is protected. For other shareholders, however, the bylaws do not cover all the different issues that could potentially arise. Accordingly, some shareholders also decide to have a shareholders’ or a buy-sell agreement in place.

A shareholders’ and buy-sell agreements include provisions designed to resolve some of the following issues:

  • What happens if a shareholder dies, becomes disabled, or is fired as an employee of the Company? Will the Company be permitted to force a buy-out of that shareholder’s interest? Will such a buy-out be mandatory or optional?

  • If there is a buy-out of a shareholder by the Company or remaining shareholders, will the price be discounted in certain circumstances?

  • In the case of cannabis licensee corporations, what happens if one shareholder is convicted of a felony and jeopardizes the license?

  • Are there certain corporate actions that will require more than a majority of shareholders to consent? Are there limitations on actions that may be taken by the directors without seeking shareholder consent?

  • Are there multiple classes of shares? What are the voting and priority rights of specific classes of shares?

  • Are there limitations on whether or not a shareholder can leave the Company by selling his shares to an unrelated, 3rd party? Should the corporation itself or remaining shareholders have a rights of first refusal? If there is a buy-out, how will the shareholder’s interest be valued and what will the payment terms be?

  • What happens if a shareholder leaves or is fired from the corporation, can that shareholder start or become involved in a competing business?

These are just some of the many provisions that can be included in a shareholders’ agreement. While corporate bylaws include general provisions as to how the corporation will operate, a shareholders’ agreement goes into a lot more depth on specific issues that may arise between shareholders. This is why it is crucial that shareholders of a corporation enter into a shareholders' agreement with all other shareholders. This can potentially avoid expensive and needless litigation that can arise if these issues are not agreed upon before they occur.

Although this article focuses on shareholders’ agreements in a corporation, there are similar agreements in other business entities. For instance, in a limited liability company, many of these provisions are included in the operating agreement. In a general partnership, these provisions are included in the partnership agreement.

Regardless of the type of business entity, if you have a business and want to ensure that you are protecting your financial interests in the best way possible, M&L’s corporate team provides expert advice on a full range of legal transactional matters. If you have any questions or would like to speak with our attorneys to further discuss our services, please feel free to reach us via email (info@margolinlawrence.com) or phone (323-653-9700).

 

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This blog is not intended as legal advice and should not be taken as such. The possession, use, and/or sale of marijuana is illegal under federal law.