Canada: Why Do You Need A Shareholders’ Agreement?

Last Updated: February 18 2011
Article by Deborah Stern, BComm, CPA, CA

A shareholders' agreement is a contract between all or some shareholders of a corporation, which allows them to establish their mutual rights and obligations.

Shareholders' agreements are important whether you have a family-owned business or unrelated shareholders. At best, it is a complex document and (should be) a comprehensive one as well, covering many issues. However, problems arise when it does not include certain points.

Some matters that should be resolved and included in a shareholders' agreement are:

  • Are spouses allowed to work in the company?
  • What is the "base" salary for each shareholder?
  • What is each shareholders' entitlement to vacation pay and benefits?
  • When calculating and allocating shareholder bonuses, is there a minimum/maximum amount?
  • With respect to income splitting, what amount of salaries to spouses is permitted?
  • What is the amount of any dividends?
  • Who approves the dollar limits for capital expenditures?
  • What happens to shares on death of a shareholder?
  • What are the criteria to sell the company?
  • Does the decision have to be unanimous?
  • What happens when a shareholder wants to sell his/her shares? Who gets first right of refusal?
  • Who approves any material change in the business? Is unanimous consent of all shareholders required?
  • What happens when a shareholder is physically or mentally disabled – short term and long term?
  • Are performance evaluations implemented for all family members?
  • When is a formal valuation of the business done? By whom?
  • Have a retirement age and process been set?
  • Has a succession plan been established? Is there a plan to bring in new shareholders (i.e., next generation)?
  • Is there a non-compete clause in case a shareholder wants to start a similar business on their own?
  • Are the shareholders required to provide personal guarantees for company loans?

Other criteria to consider for children working in the family business include:

  • What are the formal training requirements?
  • What will the compensation be?
  • What is the entitlement to vacation pay and benefits?
  • Are they required to work outside the family business for a minimum number of years? If so, how many?
  • Will they have to work in the company for a "probation" period?
  • What are the career advancement opportunitites?
  • What are the employment contract term and renewal provisions?
  • What is the definition of "just cause" for termination?
  • What is the severance entitlement?
  • What is the confidentiality provision?
  • What are the non-competition and non-solicitation covenants?
  • Are the children working for the company for the "right" reasons?
  • Which children are eligible for a summer job placement at the company? How will decisions be made and approved for hiring and firing children?

When developing a shareholder agreement, it is especially important to include an exit strategy. If a shareholder wants to leave, how will the shares be valued? Over what period of time will he/she receive the sale proceeds? Will there be a non-compete clause so he/she can't start a competing business for a certain number of years? These are all questions you must ask yourself and subsequently address when drafting your agreement.

Additionally, there are other items you might want to think about such as a buy-sell provision, also known as a 'shotgun clause'. This clause allows one shareholder to make an offer to buy another shareholder's shares or, if rejected, to sell their own shares at the same price.

Most shareholders significantly underestimate the time and level of emotion that can be involved in drawing up a shareholders' agreement.

Unfortunately, in too many cases, the shareholders cannot work through the emotional issues and as a result, the agreement never gets finalized. This can have disastrous results in the event of an unexpected change such as disability or divorce in a shareholder's life. Furthermore, we have learned from experience that the best time to draft a shareholders' agreement is when none of the parties are personally involved in the situations the agreement is designed to cover.

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.

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Deborah Stern, BComm, CPA, CA
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