In many ways the relationship between the shareholders of a company is akin to that of a marriage. In both cases the parties involved set out with the best of intentions but there are bound to be both good and bad times as circumstances change along the way. One can think of a shareholders’ agreement as being equivalent to a marital agreement for a company. You hope to never need it but will surely be glad it’s there in case you do.
During the initial honeymoon phase of operating a company, the shareholders may be cruising along and on the same page with respect to all important business decisions. The company may be growing fast and it may even be starting to show a profit. In these good times it may be difficult to see why a shareholders’ agreement may be needed. Things are working great now, why should they change?
Why do today what you can put off thinking about until tomorrow? The unfortunate reality is that the vast majority of businesses inevitably come across hard times at some point in their development and as a consequence shareholder realities can change in a hurry. At some juncture down the road it may simply be best for all parties involved to “divorce” and move on. In this scenario, being able to fall back on the guidelines established in advance by a shareholders’ agreement prepared when cooler heads prevailed is much preferable to the alternative.
Putting in place a shareholders’ agreement when things are going well is far easier than trying to negotiate one in the future at a time when relations between the shareholders might have become strained. Failure to put such a framework in place can often lead to very contentious litigation that is just as antagonistic as the worst divorce actions. Litigation between shareholders can be extremely time consuming and costly and, more importantly, can easily cripple and ultimately destroy the underlying business.
One potential way to ensure that your company is not embroiled in a long and drawn-out death dance once shareholder relationships sour is to include some form of a compulsory buy-out provision in a shareholders’ agreement, the most well known and effective form of which is the shotgun clause.
The operating premise behind this relatively simple and effective provision can be analogized to that old fairness adage “I’ll cut the pie and you choose a half”. Under the terms of a shotgun clause, a shareholder desiring to offer all but not less than all of its shares in the company (the “Instigator”) may initiate the buy-out process by giving notice to the other shareholder. This notice will set out the terms, including the price, on which the Instigator wishes to purchase the other shareholder’s shares. Delivery of the notice puts the ball in the court of the other shareholder who is then granted the option to either sell their shares to the Instigator at the per share price and on those certain terms proposed by the Instigator, or alternatively to purchase the Instigator’s shares at that same per share price and on those same terms.
The primary advantage of a compulsory buy-out clause, such as a shotgun clause, is that it provides certainty by putting in place a procedure and, most importantly, a hard and fast timeframe for resolving potentially devastating shareholder disputes. This benefits all parties in that it ensures that the shareholder who values the company most ends up with control of the company while the other is compensated fairly for their interest, all while preserving the value of the company as much as possible.
Just as marital agreements are today being utilized with increasing frequency, shareholders agreements should be a must for anyone considering entering into a corporate relationship with one or more other parties. The cost of having your lawyer prepare a shareholders’ agreement will be an insignificant cost if it prevents or limits a dispute down the road.
To discuss putting a shareholders’ agreement in place for your company, or for further information, contact one of our Shareholder Agreement lawyers.