The Basics of Shareholder Agreements

Business man looking over financial data on a laptop while using a smart phone while shareholder across table gestures in front of papers with financial data.

You've set your business up with the Secretary of State. Now it's time to look inward and say, what do we need to properly run this business?

“This step is often overlooked,” says business attorney and Hendershot Cowart shareholder Ray Panneton. “People get a nice certificate from the state that says, congratulations your business is formed!

“The question now is, how does that business operate internally? Having governance documents in place, such as a shareholder agreement, is critical. These written documents will dictate how the entity is run, who has what authority, and what's going to happen in the event of a dispute."

Without one, your entity will be governed by state law, which may not accurately reflect the intent, duties, or preferences of shareholders.

What Is a Shareholder Agreement?

A shareholder agreement is a legal document that outlines the rights, responsibilities, and obligations of shareholders in a company. Its primary purpose is to establish a framework for the governance and management of the company, as well as to protect the interests of the shareholders.

Shareholder agreements are not templates that should be duplicated for every business with shareholders. Instead, a shareholder agreement is most effective when customized to the specific needs of a business.

Who Needs a Shareholder Agreement?

Any company – whether organized as an LLC, Corporation, or partnership – with more than one shareholder, especially if they are actively involved in the business, should have a shareholder agreement.

Shareholder agreements are especially essential in businesses with:

  • Unequal ownership: When shareholders have unequal ownership percentages, the agreement ensures everyone understands their voting rights, control, and profit distribution.
  • A complex business structure: Companies with complicated ownership structures, subsidiaries, or intellectual property considerations need a well-defined agreement.
  • Family or friends as shareholders: Involving family or friends can involve emotional complexities. An agreement can establish clear boundaries and prevent future misunderstandings.

What Do Shareholder Agreements Cover?

While the specific content of a shareholder agreement can vary depending on the needs of the business, it typically addresses the following key issues and areas of potential conflict:

  • Ownership and Equity Distribution: Defines how the company's shares are allocated among the shareholders and may include provisions for the issuance of new shares, transfer restrictions, and pre-emptive rights.
  • Management and Decision-Making: Specifies how the company will be managed and the decision-making process. This may include details on the appointment of directors, voting rights, and procedures for major decisions.
  • Roles and Responsibilities: Outlines the roles and responsibilities of each shareholder, including any specific contributions they are expected to make to the company.
  • Transfer of Shares: Sets out the conditions under which shareholders can transfer their shares and any restrictions or rights of first refusal that may apply. May also establish a valuation method to establish a purchase or sales price for individual shares.
  • Dividends and Distributions: Establishes how profits will be distributed among the shareholders, including any rules for declaring dividends.
  • Dispute Resolution: Includes mechanisms for resolving disputes among shareholders, such as arbitration or mediation processes, to avoid legal battles that could harm the company.
  • Exit Strategies: Addresses what happens in the event of a shareholder's death, disability, or desire to sell their shares. This may include buy-sell provisions, drag-along rights, and tag-along rights.
  • Confidentiality and Non-Compete Clauses: Protects sensitive information and may restrict shareholders from engaging in competitive activities.
  • Financing Arrangements: Addresses how the company will secure funding, whether through loans, equity offerings, or other means, and how existing shareholders may be affected.

Is A Shareholder Agreement Necessary?

A shareholder agreement is not legally required in Texas, but it is critical to the smooth operation of a business and is recommended for any entity with more than one shareholder. For complex companies with multiple shareholders and investors, a formal agreement is even more crucial.

Even if you and the other shareholders verbally agree or believe you have a shared understanding of how authority and responsibility will be shared, this may not prevent misunderstandings or divergent interpretations of your verbal agreement down the road.

What Happens If There Is No Shareholder Agreement?

When a client comes to us about a shareholder dispute, our first question is: Do you have written agreements in place?

Without a written shareholder agreement:

  • How will you determine the value of shares should one shareholder wish to exit the business?
  • If one shareholder commits fraud or neglects their duties, how will you remove them?
  • What happens if disagreements arise over dividend payments or compensation packages?
  • What if a shareholder uses trade secrets to compete against the business under a separate entity?
  • What if majority shareholders cease to communicate or distribute dividends to minority shareholders? What are their rights?
  • What if shareholders disagree about a business decision?
  • What will you do if a shareholder diverts company funds into a personal bank account?

These are all disputes our law firm has encountered or litigated. A shareholder agreement that outlines what should happen in these situations can resolve the dispute faster and more cost-effectively. Without one, your entity will be governed by state law which does not necessarily account for the details of your business and its relationship with shareholders.

Is It Too Late to Implement a Shareholder Agreement?

The best time to put a shareholder agreement in place is as early as possible – ideally at the formation of the company when the first shares are issued. That said, it is never too late to put a shareholder agreement in place.

Here are some opportunities to introduce and execute a shareholder agreement:

  • New shareholder comes on board: When bringing in a new shareholder, take this opportunity to introduce (or update) a shareholder agreement to reflect the rights and responsibilities of all shareholders – new and existing.
  • Significant change in ownership: If the ownership structure changes significantly, you may have an opportunity to set right any tasks or issues overlooked when the company was initially formed. Introduce a shareholder agreement and ensure it reflects the current situation.
  • Before a deadlock or dispute arises: Once a company faces a deadlock or dispute between shareholders, the time for coming to a clear agreement may have passed. Engage with shareholders now about their expectations and set those down in a formal written agreement.

How To Create a Shareholder Agreement

Consult with a lawyer who practices corporate or business law to ensure your agreement is legally sound and addresses all relevant issues. Your attorney will ask a variety of questions to draft an agreement customized to your business and its relationship with its shareholders.

Other factors your attorney will take into consideration include:

  • Compliance with relevant laws and regulations: The agreement must comply with applicable corporate and securities laws.
  • Tax implications: Understanding potential tax consequences of certain provisions is essential.
  • Scalability and adaptability: The agreement should be flexible enough to accommodate future growth and changes.
  • Type of business and industry: Understanding the company's business environment helps tailor the agreement to its specific risks and opportunities.

When discussing the agreement with your attorney, be transparent in discussing your objectives and concerns to ensure the agreement accurately reflects your intentions and protects the interests of all involved.

Houston Contract & Agreement Lawyers Trusted Throughout Texas

Shareholder agreements are the backbone of a successful business venture, and our team at Hendershot Cowart P.C. is dedicated to ensuring they are properly drafted to protect against conflict and tailored to the specific needs of our clients.

To learn more about our services, or to discuss a potential business formation or shareholder agreement with an attorney from our team, call (713) 909-7323 or contact us online.

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