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Start Ups and Emerging Companies – 101: Shareholder Agreement

January 14, 2013

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There are three main purposes of the Shareholder Agreement (also known as a "Buy/Sell Agreement").  They are:

(1)  to place restrictions on the transfer of a shareholder's shares in the company;
(2)  to provide a mechanism for re-purchasing the shares in the event of the shareholder's death, disability,  breach, bankruptcy, divorce or withdrawal; and
(3)  to establish voting rights among the shareholders.

Restrictions on Transfer:  When co-founders join to start a new business together, they may not be thinking that their partner may need (or want) to sell his shares early and exit the company.  If the shares are sold, the other founder may suddenly find himself in business with someone else.  Restrictions on transfer in a Shareholder Agreement will protect against this occurrence.  Generally, the shareholders may agree not to sell their shares except to each other, or to a trust as part of the shareholder's estate planning. 

If this type of restriction is too restrictive, the founders may decide to grant each other rights of first refusal.  This means that a shareholder may not sell his or her shares without first offering the shares to the other shareholders (or the company).  If the other shareholders (or the company) do not elect to purchase the shares, then the shareholder is free to transfer the shares to the third party.

Option Events:  The shareholders should also consider describing the events that constitute an "option event" or "buy/sell event" that triggers a purchase of the shareholder's shares by the other shareholders (or the company).  Option events may consist of:

  • a transfer in violation of the Shareholder Agreement;
  • the bankruptcy or insolvency of a shareholder
  • the divorce of a shareholder
  • the death of a shareholder
  • the disability of a shareholder
  • the withdrawal of a shareholder from the company (or termination from employment)

When an "option event" occurs, the Shareholder Agreement describes the consequences that follow, which is typically that the other shareholders (or the company) will have the option to purchase the shares at fair market or a discounted price (e.g. book value).  The one exception is in the case of divorce.  Typically, the shareholder involved in the divorce would have the ability to purchase his or her spouse's community property interest in the shares in the event a petition for dissolution is filed. 

The Shareholder Agreement defines the repayment terms (which may be an interest bearing note) and timing on the transfer.

Voting Rights:  Founders may also find it important to define certain voting rights among the founders/shareholders.  For example, the shareholders may decide that the company may only be sold, and the purpose of the corporation may only be changed, with a "supermajority" vote of the shareholders, which may be 75% - 100% of the shares.  This would prevent a few shareholders from making these decisions without substantial shareholder involvement.

 

For more information, please contact:

Derek Ridgway

925-746-8484 Direct Phone
925-746-8493 Fax

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