What are Typical Provisions of a Shareholder Agreement?
A shareholder’s agreement is the arrangement between a company and its shareholders. The agreement describes the shareholder’s privileges and protection, management of the company, ownership of shares, rights and relationship regulations. It provides safeguards for minority positions and makes allowances for the resell of shares. Prior to purchasing stock, a shareholder should review the agreement for typical provisions.
Unanimous Shareholder Agreement
A unanimous shareholder agreement restricts the powers of the directors. If shares are sold after the original agreement, new shareholders are required to sign a share restriction agreement, in lieu of the unanimous shareholder agreement. A share restriction agreement generally provides for the right of first refusal in favor of the company.
Board of Directors
The shareholder agreement may provide representation for the shareholder on the board of directors. Provisions should include the size of the board and the process for elections. Many agreements allow a shareholder one vote for each share owned to nominate directors.
Observer Rights
An observer is a shareholder that is not represented on the board of directors, but is entitled to be present at board meetings and receive the same records as a board member. Observer rights do not provide for voting privileges on corporation or other matters. If a person’s holdings fall below a certain level, the shareholder may be excluded as an observer in highly sensitive discussions.
Procedural Matters and Covenants of the Corporation
Provisions for dealing with the frequency of board meetings, calling an unscheduled board meeting and other related matters are generally included in the agreement. Consideration should be given to ensure that these provisions do not conflict with the by-laws. Corporation obligations to provide financial statements within particular timeframes to investors, information on acquisitions and protection for the board of directors should be entered into as a covenant of the corporation within the agreement.
Dilution of Ownership Interests
Prior to purchasing a share, the potential buyer should review the agreement for protective rights from dilution of ownership interests by the future issuance of shares. Investors may require a right to participate in decisions to offer options, shares or other securities. Dilution of ownership interests sometimes extends only to founders and employees and may include a minimum threshold of share ownership.
Transfer, Restriction and Other Matters Related to Shares
Transfer of shares is usually prohibited except as allowed in the shareholder agreement or by consent of the majority of shareholders. The shareholder agreement should allow a certain amount of flexibility in transfers for tax planning purposes. When transfers are permitted, provisions in the agreement should bind the new shareholder to the original agreement. Corporations will often retain a right in the agreement to repurchase shares owned by a founder upon death, insolvency or divorce.