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Importance of Shareholder Agreement When Dispute Arises

If you start a company and decide on 50/50 split ownership with a good friend or business associate, one of two things inevitably occur. The new business is either successful or within the first few years it struggles to generate profit and falls apart. Even most successful companies go through tough times at some point. The harsh reality is that regardless of whether you are successful or not, co-founders often find themselves in disputes about how the company should be run and managed. While most start-ups are too busy focusing on building great products and services and conducting business development, they forget to run their company when it comes to financial and legal requirements.

Most issues revolve around the following concerns: the hiring and firing of employees, purchasing equipment and major assets, authority to sign cheques and other financial documents, decision to issue dividends and salary, decision to reinvest capital back into the venture for growth purposes, raising outside investment or offering shares to employees, amending corporate documents, and selecting what corporate opportunities to pursue, among other things.

Aside from management issues, both unsuccessful and successful companies often face a number of potential disputes on their paths to growing revenue. A well drafted shareholder agreement protects a business and its shareholders from many disputes that can potentially arise, including the following common issues and scenarios we have seen:

  • One shareholder needs to take a full-time (or part-time) job somewhere while the other becomes unhappy about this given 50/50 split ownership;
  • You face tough calls on cutting costs and disagree on the direction of the company with your co-founder. With no clear agreement on management, there is a fight over whose direction prevails;
  • Shareholders cannot decide on issuance of new shares and bringing of new investors onboard;
  • A co-founder may want to sell his or her shares; however, there is no agreement in place on who they can be sold to and on what terms;
  • There is no agreement in place with respect to deciding how or whether profits should be reinvested or paid out as dividends to shareholders;
  • Where a co-founder stops showing up at work for personal or medical reasons, he or she may still expect a pay cheque and dividends; and
  • Where a co-founder passes away or gets divorced, his or her shares may be transferred to the spouse who now owns half of the business.
  • A co-founder may leave and take customers with him or her.

It is important to understand that these issues and situations are compounded and become even more significant and complex if there are three or more shareholders in a company. Some shareholders try to wait until their business is already generating revenue to put together a shareholder agreement to address management issues and shareholders rights. The problem, however, is that its much harder to agree on how these issues will be dealt with after they arise. Therefore, new ventures that decide to draft a shareholder agreement and agree on how to manage these issues upfront, are the ones best prepared to prevent future disputes, and as a result, best positioned to succeed.