Shareholders Agreements
Shareholders agreements are the cornerstone of a corporation's (and an LLC's for this purpose) internal relationships. Not having one between multiple owners is inexcusable, creates basically a tyranny of the majority, and will inevitably lead to hurt feelings and a potential financial disaster for minority shareholders.
Without one, there is no way for the majority to force the minority to sell their stock; and likewise no way for the minority shareholders to force the corporation or the other shareholders to purchase their stock in order to exit the corporation. The majority can dominate the minority, and often cut off the minority's income from the business (even the founder should he or she inadvertently slip below 50% can have his or her employment terminated and be left without any income from the company and no way to sell out). It's also very unlikely that any prospective buyer of a company will purchase it without being able to acquire all of the stock -- so a minority holdout can scuttle the entire sale, or extract from the majority a substantial bonus as a condition of agreeing to a sale of the business.
A properly structured shareholders agreement needs to address among other things the fundamental issues of (i) how do we structure control of this company, (i) how do we value it for the purpose of buying out a shareholder, and (iii) who can force a purchase or sale of shares either for their own account or by the other shareholders?
Don't settle for just a first right of refusal amongst your shareholders (as many, many shareholders agreements unfortunately do), since practically speaking that puts any minority shareholder in a position of being unable to unload their shares. No outsider wants to put in the time, money and energy to submit an offer for those shares; just to be bumped by the majority buying those same shares in the end -- and who would buy a minority position anyhow, just to inherit the same helpless minority shareholder position held by the seller with no right to any income from the company?
The area of exit strategies is extremely delicate, and there should be no fewer than three or four different ways for the shareholders to disengage from one another without causing hard feelings and filing lawsuits. The parties need to be creative here, and structure these scenarios very carefully.
Our firm also uses shareholders agreements as the foundation for most pre-planned exits; i.e., for internal succession planning of a sale to key employees or family members or both. It's incredibly useful to set that all of that up in advance, often funding it with life insurance, and taking the worry off of the majority owner(s) or their spouses as to what is going to happen to their company in the event of death or disability, etc. It also creates an on-ramp for younger key employees to know that they are going to have an opportunity to buy this business on down the road a few years, and prevent them from leaving to find another company where they can buy in. We'll often refer to these as a "deferred pre-sale"; i.e., it's signed and totally binding on all parties now, but the actual event might be many years away.
A shareholders agreement is also a great opportunity to bind key employees to a non-compete where they may not have had one previously; it can constitute the necessary timely and legally sufficient consideration for them agreeing to become bound by a set of restrictive covenants, and can thereby increase the value of the company dramatically just by protecting its trade secrets and confidential information and precluding employees from going off to work for a competitor or just starting their own competing business. An intellectual property based company may be virtually unsalable without non-competes in place covering all of its key employees.
Without one, there is no way for the majority to force the minority to sell their stock; and likewise no way for the minority shareholders to force the corporation or the other shareholders to purchase their stock in order to exit the corporation. The majority can dominate the minority, and often cut off the minority's income from the business (even the founder should he or she inadvertently slip below 50% can have his or her employment terminated and be left without any income from the company and no way to sell out). It's also very unlikely that any prospective buyer of a company will purchase it without being able to acquire all of the stock -- so a minority holdout can scuttle the entire sale, or extract from the majority a substantial bonus as a condition of agreeing to a sale of the business.
A properly structured shareholders agreement needs to address among other things the fundamental issues of (i) how do we structure control of this company, (i) how do we value it for the purpose of buying out a shareholder, and (iii) who can force a purchase or sale of shares either for their own account or by the other shareholders?
Don't settle for just a first right of refusal amongst your shareholders (as many, many shareholders agreements unfortunately do), since practically speaking that puts any minority shareholder in a position of being unable to unload their shares. No outsider wants to put in the time, money and energy to submit an offer for those shares; just to be bumped by the majority buying those same shares in the end -- and who would buy a minority position anyhow, just to inherit the same helpless minority shareholder position held by the seller with no right to any income from the company?
The area of exit strategies is extremely delicate, and there should be no fewer than three or four different ways for the shareholders to disengage from one another without causing hard feelings and filing lawsuits. The parties need to be creative here, and structure these scenarios very carefully.
Our firm also uses shareholders agreements as the foundation for most pre-planned exits; i.e., for internal succession planning of a sale to key employees or family members or both. It's incredibly useful to set that all of that up in advance, often funding it with life insurance, and taking the worry off of the majority owner(s) or their spouses as to what is going to happen to their company in the event of death or disability, etc. It also creates an on-ramp for younger key employees to know that they are going to have an opportunity to buy this business on down the road a few years, and prevent them from leaving to find another company where they can buy in. We'll often refer to these as a "deferred pre-sale"; i.e., it's signed and totally binding on all parties now, but the actual event might be many years away.
A shareholders agreement is also a great opportunity to bind key employees to a non-compete where they may not have had one previously; it can constitute the necessary timely and legally sufficient consideration for them agreeing to become bound by a set of restrictive covenants, and can thereby increase the value of the company dramatically just by protecting its trade secrets and confidential information and precluding employees from going off to work for a competitor or just starting their own competing business. An intellectual property based company may be virtually unsalable without non-competes in place covering all of its key employees.