When Should Your Draft Your Shareholder Agreement?
Shareholder Agreement
Shareholder agreements should be drafted when the corporation is first formed, but they can be profitably be revised at various points along the trajectory of the corporation, as different challenges arise. Different provisions in shareholder agreements become more important during different phases of the company’s life cycle.
Initially, the founders of the company may be most interested in the shareholder agreement’s transfer restrictions and mechanisms for resolving deadlock. They may want to be sure that their partners will not sell stock to an outsider without their approval. They may want to know what happens when triggering events such as a divorce, death or disability occur.
Investments and Shareholder Agreements
As the company grows, it may receive investments from private equity or venture capital. The entities making such investments are generally very concerned about the control they will have over the corporation. They may insist on a shareholder agreement that spells out structure of the board, appointment of officers, and information rights, as well as transfer restrictions, preemptive rights, and mechanisms for resolving deadlock. They may want preferred stock or debt instruments rather than common stock, to maximize flexibility and profit.
Even if the company does not receive investments from private equity or venture capital, the owners may want a shareholder agreement as they begin thinking about successor ownership and management of their business. As the partners begin to do estate planning, they may become more concerned about buy-out rights and transfer to heirs. They may become more concerned about needs for liquidity or for income for a surviving spouse.
S-Election and Shareholder Agreements
When a company makes an S-election or changes its structure in other ways, a shareholder agreement is important to make sure that any transfer will preserve the requirements of the new structure. For instance, a transfer by a shareholder to a corporation or a limited liability company could ruin an S-election.
In any event, a shareholders agreement should be executed before there is a falling out among the owners. If there are no agreements about composition of the board of directors, a founder may be voted off the board by a coalition of disaffected founders. Without buy-sell mechanisms triggered by a shareholder no longer working actively in the business, a shareholder may even go to work for a competitor yet keep her shares, including all the rights to information which accompany such shares.