What Should You Include In Your Shareholders’ Agreement?

As a follow up to last week’s post, “Why You Need a Shareholders’ Agreement“, the following is an overview of some common provisions that are often included in unanimous shareholders’ agreements (“USAs”).¬†However, the provisions below¬†may or may not be appropriate in your situation. Your USA should be constructed to accomplish your specific goals in your specific circumstances.

Decision Making

In the absence of a USA, day-to-day management of a corporation’s business and affairs is left to the board of directors and the officers the board of directors appoints. This would include such things as hiring employees, entering into agreements, borrowing money, pledging the corporation’s assets as security, issuing additional shares, and paying dividends. Shareholder approval is generally limited to (i) the election of directors and the appointment of auditors of the corporation, and (ii) certain fundamental changes relating to the corporation, such as changing the articles of incorporation or selling all or substantially all of the corporation’s assets.

A USA can take responsibility for any or all decisions relating to the business and affairs of a corporation away from the directors and officers and vest such authority in the shareholders directly, thereby giving a shareholder who is not also a director some control over the day-to-day operations of the corporation. For example, the USA may give a minority shareholder a right to proportionate representation on the board of directors, the ability to veto fundamental changes if the shareholder does not have the votes to otherwise block the changes, or require minority shareholder consent, either alone or as a part of a minority group, for certain major decisions.

Conversely, a majority shareholder may need seek protection under the USA by including provisions listing the kinds of decisions that require a specified level of consent, but set at a level within the majority shareholder’s holdings (either alone or in combination with another friendly shareholder).

Pre-Emptive Right

A pre-emptive right (sometimes called a participation right) gives existing shareholders the right to purchase, on a proportionate basis, any new shares issued by the corporation before such new shares are offered to a third party.

Minority shareholders can use a pre-emptive right restrict the ability of the majority shareholders to dilute the shareholdings of the minority shareholders by causing the corporation to issue new shares.

Note that even if a pre-emptive right exists to protect a minority shareholder, the minority shareholder must still have the funds to purchase the new shares at the time they are offered to him or her.

Where shareholders hold equal interests in the corporation, the USA may contain a general prohibition against issuing new shares unless all shareholders agree. In such circumstances, a pre-emptive right may not be necessary.

Right of First Refusal

A right of first refusal (“ROFR”) allows a shareholder (the “seller”) to find a third-party buyer for its shares. If the third party is firm in its commitment to purchase the seller’s shares, then the seller is required to give notice to the corporation and/or other shareholders. The notice typically must specify the price and terms of the proposed sale to the third party, and will constitute an offer by the seller to sell its shares to the other shareholders at the same price and on the same terms on which the third party is willing to purchase them. Under the ROFR provisions, the third-party sale can proceed only if the other shareholders (or the corporation, if applicable) decline to purchase all of the seller’s shares at the same price and on the same terms specified in the notice.

Note that if a ROFR is triggered and the remaining shareholders (or the corporation, if applicable) cannot afford to match the purchase price on the terms offered by the third-party buyer, then the third-party sale may ordinarily proceed and the third party will become a shareholder.

Tag Along Right

A typical tag along right (sometimes called a piggy-back right) arises when a ROFR has been triggered and the remaining shareholders do not elect to purchase the seller’s shares under the ROFR but instead want the third party to purchase their own shares as well as those of the seller. The third-party sale is permitted to proceed only if the third party commits itself to purchase not only the original seller’s shares but also the shares of all shareholders who elected to exercise their tag along rights.

Drag-Along Right

A typical “drag along” right enables some specified majority of the shareholders to enter into an agreement, as agent for and on behalf of the corporation and all of the other shareholders, providing for the sale of all of the shares of the corporation.

Purchase Option

A number of events may occur in relation to a shareholder (the “disposing shareholder”) that may: (i) cause legal or beneficial title in the shares held by the disposing shareholder to pass to a third party, or (ii) result in the other shareholders wishing to remove the disposing shareholder from the corporation. By including appropriate provisions in a USA, the occurrence of such events (“disposition events”) can give rise to an option on the part of the corporation, certain other shareholders and/or all of the other shareholders to purchase the shares of the disposing shareholder. This acquisition right is typically framed as an option rather than an obligation. Typical disposition events include bankruptcy/insolvency, death or mental incapacity, prolonged disability, court order purporting to deal with the shares under matrimonial property legislation, ceasing to be employed by the corporation, or a change of control of a corporate shareholder.

Share Value Issues: The price at which shares of a disposing shareholder are sold pursuant to the purchase option arising on the occurrence of a disposition event is ordinarily that resulting from the valuation rules specified in the USA. There is no restriction on the manner in which such value is to be determined. The value can be fixed in advance, or a valuation formula can be agreed to by the shareholders. Different valuation criteria may be prescribed for transfers occasioned by different events or occurring at different times. The three most common methods for determining the price to be paid for the shares of a disposing shareholder are (i) a value that is fixed in advance and updated periodically or reviewed annually; (ii) a value established by a formula in the agreement; or (iii) a value that is determined by an independent third party or the company’s accountant or auditor.

Insurance Considerations: Where practical and economic, it may be advisable for shareholders to place, or more typically to have the corporation place, insurance on the lives of the shareholders. Not only does this provide a source of funds to effect a buy-out on the death of a shareholder but it also may provide a fund of money (so called “key man” insurance) to supplement operations during what may be a rough patch brought on by the deceased shareholder’s absence.

Shotgun Provision

A “shotgun” provision is frequently included in a USA as a dispute resolution mechanism to resolve deadlock or a falling out between shareholders. If invoked, the result will likely be the departure of one of the disputants from the corporation.

A typical shotgun provision under a USA permits a shareholder to make an offer to purchase all of the shares of the other shareholders for a specified price and on specified terms. The other shareholders are then required to, at their option, either: (i) sell their shares to the offering shareholder for the price and on the terms set out in the shotgun offer, or (ii) purchase the shares of the offering shareholders for the same price and on the same terms set out in the shotgun offer.

Shotgun provisions are not, however, without complication. Where there are more than two shareholders and a shotgun offer is made to multiple shareholders, complications may arise as to who is obligated to purchase what shares, particularly if the receiving shareholders are not all of the same view with respect to accepting or rejecting the shotgun offer. A shotgun clause is also generally inappropriate as between shareholders having significantly different shareholdings and/or abilities to raise the funds necessary to purchase shares under the shotgun provisions. If, for example, a significant shareholder with considerable financial resources invokes the shotgun procedure and offers to purchase the shares of smaller shareholders at a discounted price, such other shareholders are faced with the prospect of either selling their shares at the low price or buying out the significant shareholder at what may be a large aggregate cost. If the smaller shareholders lack the resources to purchase the significant shareholder’s position, then the shotgun will effectively force them to sell their interests at the discounted offer price.

Confidentiality, Non-Competition and Non-Solicitation

If a shareholder holds special information or has the ability to go into direct competition with the corporation, this can create difficulties for the company while that person remains a shareholder and certainly afterwards. If there is a buy-out, the remaining shareholders do not want to spend a great deal of money to obtain the shares of the withdrawing shareholder, only to find the withdrawing shareholder is setting up business in competition immediately after the closing of the sale. Where it is appropriate, consideration should be given to building non-competition and confidentiality covenants into the shareholder agreement itself. Consideration should also be given to a non-solicitation (sometimes called a “no-hire”) provision so that the departing shareholder does not take key employees with him or her into the departing shareholder’s new venture.

Funding Requirements

A corporation requires access to capital both upon incorporation and during operation. A shareholder agreement can prescribe how such capital be obtained and ensure that each shareholder contribute the requisite amount in conjunction with his or her interest in the corporation or face a penalty for failure to do so. In the case of debt financing, a shareholder agreement can prescribe how guarantees are to be signed and provide for the sharing of liability amongst shareholders.


Arbitration provisions are often included in shareholder agreements in the hope that disputes will be resolved faster, without damaging the parties’ relationship, and in a manner that will ensure that confidential information does not become public.