Privately held corporations with multiple shareholders often enter into shareholder-level agreements that define the relationship between the shareholders and the company. This entry discusses issues that clients commonly deal with through shareholder agreements.
Shareholder agreements often restrict a shareholder from selling their stock to a third party buyer. Sometimes, the shareholders agree to allow sales of stock, but only after the company and the other shareholders receive a first and second right of refusal or a right of first offer. Transfers to family members or trusts for family members may be allowed for estate planning purposes. If a corporation is an S corporation, transfers to ineligible S corporation shareholders are normally prohibited altogether.
A shareholder agreement will often define the terms that will apply in the event of the death of a shareholder, disability of a shareholder, termination of a shareholder's marriage, termination of a shareholder's employment with the company and in the event that a shareholder experiences a bankruptcy or insolvency. The company may receive an option to acquire the shareholder's stock in such circumstances or the company may be required to redeem the stock. Alternatively, the shareholder or its estate may have an option to sell the stock back to the company. The company or the shareholders may be required to maintain insurance policies on the lives of the shareholders.
In the event of a company purchase, a shareholder agreement will set forth the terms, both price and timing of payment, for the transaction, as well as the procedure for closing the transaction. A shareholder agreement often provides that the company will make distributions to the shareholders in order to fund shareholder-level taxes if the company is a flow-through entity for tax purposes. Special provisions may apply if the company engages in an initial public offering.
The parties to a shareholder agreement may agree to bind themselves to noncompetition, nonsolicitation and confidentiality provisions. They may also agree to other provisions relating to transfers of a majority interest in the company. For example, a "bring along/come along" provision would allow a majority shareholder group to force a minority shareholder group to sell their interests to a potential buyer and would allow the minority to join in such a sale to ensure that they are not left behind in the event of a sale of the company that will result in a change in control.
When shareholders discuss potential terms for a shareholder agreement, they often find the discussion helpful in clarifying their strategic plans for the future of the company. In some cases, the shareholders discover that they have very different ideas of what should occur after a significant event such as an untimely death or proposed transfer of the company. Reaching agreement on these issues is critical and is normally in the best interests of all of the parties involved.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.