With Vancouver Startup Week 2019 taking place this week, our Technology Transactions Practice Group is sharing a series of articles with tips and strategies for all of Vancouver’s innovators and disrupters who are looking to grow their tech businesses. Stay tuned for exclusive insights on our website, LinkedIn and Twitter.
There’s no law that states a company and its shareholders must have a Shareholders’ Agreement. However, these agreements perform many important functions to help protect the interests of the company and its shareholders, as well as keep the company orderly and ready for investment or exit. It is absolutely in the company’s interest to invest in getting the Shareholders’ Agreement right. Shareholders’ Agreements are often said to address the “5 D’s” – death, disability, divorce, dispute and divestiture. This article discusses these and some other common issues facing emerging companies that can be addressed in a typical Shareholders’ Agreement.
Death, Disability, Dispute and Divorce
When you and your business partners have a brilliant idea and want to start a company, these types of things are rarely top of mind. It’s important not only to set your company up for success, but also to plan for what will happen should the unthinkable occur. A Shareholders’ Agreement can help ensure the continued viability of the company when life doesn’t go as planned for the shareholders. For example, if the two founders of a company come to an irreconcilable dispute over the business, a shotgun clause in a Shareholders’ Agreement provides a way to move forward.
For an unlisted (i.e. private) company, the board must approve all share transfers as a matter of corporate law. But the Shareholders’ Agreement can provide more structure around share transfers and clarify when the board is more likely to approve a transfer. For example, shareholders are often entitled in a Shareholders’ Agreement to transfer shares to a family holding company or to an RRSP.
Additional Share Rights
Founders and investors in a company (or sometimes the company itself) often want to know that they get first dibs if any other shareholder wants to sell their shares to a third party (right of first refusal).
Shareholders also often want to know: that they can participate in all future share issuances to at least maintain their percentage share ownership (preemptive rights); that if any other shareholder is selling some or all of its shares to a third party, then they can also sell some shares to that third party (tag along or piggy back rights); and that, if a majority of shareholders want to sell their shares to a third party, that minority shareholders can’t hold up the deal (drag along rights).
Unless shareholders are employees, directors or officers of the company, they have no duties towards the company. It’s not in their interest to undermine the company (and therefore their investment). However, unless the shareholders are contractually bound to keep the company’s secrets, they don’t have to.
Governance and Approval Rights
Board appointment and composition rights are usually addressed in Shareholders’ Agreements. As a founder or an investor, if you have a specific right to nominate a director to the board, you want all the other shareholders to agree to vote for your nominee each year (as is the right of shareholders at corporate law) in a Shareholders’ Agreement. Sometimes investors also want to ensure that certain company actions receive unanimous board approval or receive shareholder approval in addition to board approval, which usually gets included in the Shareholders’ Agreement.
At corporate law, the annual financial statements must be presented to the shareholders, unless all shareholders have waived this requirement (at least for companies incorporated under BC law). Often, investors want more information throughout the year, which is can be specified in Shareholders’ Agreements.