The majority of businesses in the United States have ownership groups of less than five individuals. While this provides for efficient and effective management, problems can arise because the shareholders also serve as the management of the company. Simply put, what happens if the following occurs:
- A shareholder dies?
- A shareholder gets divorced [and the spouse is awarded half the shares?]
- A shareholder stops coming to work?
- A shareholder wants to sell there stock to some outside third party?
- A shareholder becomes incapacitated because of a medical condition?
- A shareholder wants to retire?
- Two shareholders become adversarial?
If the shareholders cannot come to an voluntary agreement at the time these and other numerous events occur, the business typically grinds to a halt and the parties go to court to request rulings from a judge. Many businesses that were otherwise successful have failed because of such disputes.
How can you avoid these problems?
The best solution is to pursue a Shareholder's Agreement before the opening of the business or soon thereafter. A Shareholder's Agreement is a contract between all of the shareholders and their spouses, if any. The purpose of the document is to address how disputes, ownership sales and other events will be addressed
before they happen.
The most common issues addressed in Shareholder's Agreement are when and how stock will be bought back by the corporation or shareholders. For this reason, the contract is also known as a "Buy-Sell Agreement". Common topics include:
- First Right of Refusal if a shareholder tries to sell their stock;
- Right of surviving shareholders to buy back stock from the estate of a deceased shareholder to avoid having the children or spouse of the deceased shareholder become stock holders. This is often combined with life insurance products to supply a means for making payment;
- Right to buy back stock from a shareholder that files personal bankruptcy;
- Right to buy back stock from a shareholder that is found to be mentally incompetent [drug addictions, etc.];
- Right to buy back stock from a shareholder that is employed with the company and fails to perform their assigned duties; and
- The retirement of a shareholder.
Each company has unique circumstances depending upon the business nature and the shareholder situation. Regardless, the Shareholder's Agreement is a smart and effective means of short-circuiting ownership disputes before they occur. If your corporation consists of a two or more shareholders, serious consideration should be given to pursing a Shareholder's Agreement.
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Richard Chapo is the lead attorney for SanDiegoEsquire.com, based in San Diego, California. He can be contacted at
Richard@SanDiegoEsquire.com. or 619-992-1867. This article is for general education purposes and does not address every facet of the laws surrounding the subject. Nothing in this article creates an attorney-client relationship.
