Shareholder Agreements – Part 2: Some Common Clauses

In Part 1, I set out some of the main reasons why I recommend small businesses with two or more active shareholders have a shareholder agreement.  In this note and in Part 3, I will describe some of the more common provisions found in those agreements.  While many clients hope that there is a “standard” shareholder agreement, I encourage them to consider what outcomes they would like if it becomes necessary to invoke the agreement due to the death or disability, retirement or exit of a shareholder for any other reason and to tailor the agreement to their own needs instead of simply adopting a model agreement.

Corporate Matters   Under this heading, it is typical to describe who the directors will be and what issues, if any, will require the approval of all of the shareholders.  For example, the parties may wish to ensure that no shareholder or director can enter into contracts above a certain value without the approval of the others.  As well, the hiring and firing of staff, particularly for very small companies, is often a matter on which everyone needs to agree.

Financing   Every business needs financing from time to time.  Whether financing comes from the shareholders by way of equity or shareholder loan or financing from an outside party such as a bank, the obligations of the shareholders should be set out, particularly if the shareholders have different percentage interests or differing abilities to raise additional funds.  For example, the business plan may call for additional capital to be raised as the business expands.  If the shareholders are expected to contribute that capital but one of them is unable or unwilling to do so at the time the funds are needed, there should be a back-up plan.  Since a business plan is not a contract, the obligations of the shareholders to provide capital or to guarantee bank borrowings should be set out in the shareholder agreement.

Non-Competition and Non-Disclosure   Since all active shareholders will likely have access to all of the company’s proprietary information such as its business plan, pricing structure, customer lists and financial results, it is usually a good idea to protect that information through non-disclosure clauses.  The information belongs to the company, not to any of the shareholders, and the company can enforce the non-disclosure agreement by seeking an injunction and damages.  Non-competition agreements have a similar purpose, to protect the confidential information of the company, but they also stop any of the shareholders from going into business that is in competition with the company.  Be aware that non-competition agreements need to be drafted carefully and must be limited in scope in order to be enforceable.  Courts take the view, quite reasonably in my view, that people must be allowed to earn a living and non-competition agreements will be reviewed by the Court to ensure that they are reasonable before they are enforced.  Another, probably less well known clause, is a non-solicitation agreement.  A non-solicitation agreement does not prohibit competition by a former shareholder but does prevent him or her from pursuing business from existing clients of the company and from trying to hire the company’s key employees.  Courts are much more inclined to enforce non-solicitation agreements than non-competition agreements.

Tag-Along and Drag-Along   A “tag-along” clause allows a minority shareholder to sell if the majority has an agreement to sell their shares to a third party.  That way, a minority shareholder is not left with a relatively small position in the company after it is sold.  A “drag-along” clause allows the majority to force the minority to sell.  This clause is particularly useful if a minority shareholder tries to hold out for a higher price and potentially prevent a sale of the whole company.

In part 3 of this series, I will address some of the common issues around the exit of a shareholder, either voluntarily or otherwise.