How To Prepare For Changes In A Shareholder’s Life Circumstances: Buy-Out Clauses A shareholders’ agreement often includes the framework within which the business relationship will be governed. It can also provide mechanisms to address the dissolution of that relationship. This entry complements our previous blog on provisions by which shareholders or the corporation, can force a share transfer. Disability, Death, or Insolvency of a Shareholder An individual shareholder’s demise, insolvency or general inability to carry out his or her duties can be challenging for the remaining business partners. A shareholders’ agreement can provide that the remaining shareholders, or the corporation itself, are obliged to purchase the shares previously held by the affected shareholder or by his or her estate, and can set out the payment terms for the transaction. It can also include life insurance provisions, pursuant to which the insurance proceeds can be applied to payment of the purchase price. Valuation Mechanism Shareholders’ agreements will typically provide a mechanism by which to determine the fair market value of the shares at a given point in time. Provisions of this type can help avoid disputes as to value and as such are particularly helpful should the business relationship become less than amicable. Transfer Restrictions The shareholders’ agreement can restrict individuals or legal persons to whom or to which a shareholder may transfer his, her, or its shares. Provisions of this nature help ensure that the remaining shareholders have a means by which to control those with whom or with which they are business partners. There are a variety of provisions that can be used in shareholder agreements to govern shareholder buyouts or provide for the sale of a company in the event of unforeseen circumstances that end the relationship between shareholders. To further discuss these provisions or other aspects of shareholder agreements, please contact Elisabeth Colson, senior corporate lawyer at Devry Smith Frank LLP. You can reach her directly at (416) 446-5048 or by email at lisabeth.colson@devrylaw.ca. “This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.” By Fauzan SiddiquiBlog, Corporate LawApril 26, 2021March 26, 2025
Shareholder Disputes: An Overview of Three Procedures to Achieve a Business Divorce While business partners will usually be totally optimistic at the time of start-up, it is important to provide for a solution to unresolvable disagreements. This post considers three different solutions by which business partners can go their separate ways. Each of these establishes a procedure whereby one shareholder can buy out the other shareholder(s) or force the other shareholder(s) to buy, or require the other shareholders to co-operate in a sale of all shares in the business. 1) Shotgun Provision The “shotgun” is the most commonly used provisions in shareholder agreements and works best with two shareholders, although it can work with more shareholders. Under this provision, one shareholder presents another shareholder with an offer to purchase all of the other shareholder’s shares in the business at a specified price. The other shareholder then has two options: i) sell all of the other shareholder’s shares in the business to the offering shareholder at the specified price; (or) ii) buy all of the offering shareholder’s shares in the business at the same price. This result is that the offering shareholder is either bought out or ends up owning 100% of the business. The shareholders’ agreement will usually, or should, set out all of the terms that will apply to any sale. There are some potential disadvantages of shotgun provisions. First and foremost, they are not ideal if there is disparity between the economic strength of the shareholders. If one shareholder has considerably more financial means than the other(s), a shotgun provision can result in a situation where a stronger party can effectively force a weaker party to sell shares to the stronger party for consideration below market value. Another issue to be considered is where one of the shareholders has considerable operating knowledge about the business that might put the other partner, especially a passive partner, at a disadvantage by having to step into managing the business when they have no past experience or contacts with the customers or suppliers. Furthermore, a shotgun provision may not be ideal in the early stages of a business. One party could choose to exit or force another party out before the business has gained much value. To avoid this, it is recommended that a provision be included in the agreement that states that the “shotgun” provision, or for that matter any similar provision, may not be exercised until after the business has been operating for a certain period of time, say three to five years. 2) Put option, with option to buy or cause sale of 100% of business One alternative to the shotgun provision is to provide the shareholders with a ‘put option’. This enables a shareholder (an “Offering Shareholder”) to request that the other shareholder(s) purchase the shares owned by the Offering Shareholder at a price specified by the Offering Shareholder. If the other shareholder(s) decide not to buy the Offering Shareholder’s shares, the Offering Shareholder has the option to buy the shares owned by the other shareholder(s) or cause the sale of 100% of the shares of the company. The advantage of this provision over the shotgun provision is that the Offering Shareholder cannot find himself forced to be the buyer. There is, however, still a risk that the other shareholder(s) may refuse to co-operate in a sale of 100% of the shares of the Company, however the agreement can contain penalties for refusal to co-operate. 3) Private Auction Provision Under a private auction, one shareholder can require that all shares in the business be placed on auction. Only the shareholders can bid at the auction. A minimum starting price and minimum bid increments can be set. The auction continues until one shareholder’s bid is accepted by the other shareholder(s) or the other shareholder(s) do not respond with a higher bid. Essentially this is a variation of the shotgun provision, that provides all shareholders with more control over the price at which shares in the business are ultimately bought or sold. The private auction also reduces the risk of stronger economic parties taking advantage of weaker economic parties because it increases the likelihood that a buyout will occur close to the market value of the shares. Summary There are a variety of provisions that can be used in shareholder agreements to govern shareholder buyouts or provide for the sale of a company in the event of a breakdown in the relationship between shareholders. To further discuss these provisions or other aspects of shareholder agreements, please contact our corporate law department to book a consultation. “This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.” By Fauzan SiddiquiBlog, Corporate LawDecember 17, 2020February 22, 2024
The Importance of Shareholder Agreements Any business that has two or more shareholders or equity investors should seriously consider having a shareholder agreement to protect not only the shareholders but also the business itself. Too often, the shareholders of a start-up business are reluctant to spend the time or money to prepare an agreement that addresses the major areas of business operations or potential areas of dispute that may arise in a jointly owned and managed business. While it is desirable to have an agreement that deals with most of the ongoing management issues in a business and the areas of potential disagreements, realistically the cost of preparing such agreement with successive meetings and drafts is not within the budget of a start-up business. However something is better than nothing, and a limited practical approach is to have what I like to refer to as a “Meanwhile Agreement.” This would take the form of two or three page listing of the most important areas of agreement between the parties without getting into the detailed “boilerplate” that usually finds its way into a 30-40 page agreement. There is always time and money available when a business evolves beyond the start-up phase and becomes profitable. There is no such thing as a standard off-the-shelf agreement that is a one size fits all document. The most effective way to ensure your shareholder agreement meets the needs of the parties is to require the parties to be involved in the process of establishing the terms of the shareholders’ agreement While a perfect Agreement is desirable, it is more realistic for the parties to feel comfortable that they can “live” with the terms of the Agreement, no matter how brief or detailed it may be. So what are we talking about? A Shareholder Agreement is essentially a private contract entered into voluntarily by all shareholders of a business, that contains the following kinds of provisions (the listing is not exhaustive), even in the simplest of businesses: the names of the shareholders the number and class of shares held by each shareholder the amount of investment by each shareholder what happens if the business requires additional capital allocation of responsibilities as between the different shareholders in the operation of the business what happens if a dispute arises between the shareholders; do the parties wish to create a mechanism for one shareholder to buy out the other How decisions relating to the business will be made; unanimity, or in the case of 3 or more shareholders, does a majority of votes rule What happens if a shareholder dies; will the shareholders, or the business take out insurance on each shareholder’s life to provide funds for a buy-out on death; what happens if a shareholder becomes incapacitated and is unable to work full-time What happens if a shareholder wants to leave the business Are shareholders required to work full time in the business Is any shareholder permitted to start another business, or do engage in a competitive activity Without some agreement that deals with what happens if a dispute arises, any shareholder can apply to the court for an order winding up the business, not a desirable result. However, if the parties have addressed this issue in an agreement, even if it is a short one, the courts will give effect to the parties’ intentions. For more information or to arrange an appointment with our business and corporate services department, email info@devrylaw.ca or call 416-449-1400. “This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.” By Fauzan SiddiquiBlog, Corporate LawDecember 1, 2017March 26, 2025
