What is a Shareholder Agreement and Does My Company Need One?

robindBusiness, Contracts

A shareholder agreement – sometimes called a stockholder agreement – details the rights and responsibilities of shareholders and their company and defines the relationship between them.

Although a shareholder agreement isn’t necessary for every corporation, it can be critical to the smooth operation of a corporation’s business, avoiding shareholder lawsuits, and resolving conflicts between the shareholders and the company.

Below, we will discuss the basics of shareholder agreements in Texas, including:

  • When your company needs or does not need a stockholder agreement,
  • What should be included in your company’s shareholder agreement, and
  • Why you should have an experienced business law attorney draft or review your company’s shareholder agreement.

What is a Shareholder Agreement?

A shareholder agreement is an essential document for many corporations that should be on your “going live” checklist for starting a new business. It governs the relationships between shareholders and the company, grants specific powers to shareholders and the company, and confers rights and responsibilities to the parties.

When Does My Company Need a Shareholder Agreement?

If you are the company’s only shareholder, you do not need a shareholder agreement.

If you are the majority shareholder in the company, but there are other stockholders, you may not need a shareholder agreement, but you should discuss the pros and cons of a shareholder agreement with your business law attorney, taking into consideration your unique circumstances.

Some examples of circumstances when your company should have a shareholder agreement in place include:

  • You are starting a new company with one or more other shareholders who are contributing equal or considerable value to the new company,
  • The other shareholders in your venture are essential to the company’s success,
  • Another stockholder is contributing capital to the company and wants a shareholder agreement to protect their investment, or
  • There are multiple stockholders, and none own a controlling share of the company’s stock.

What is Included in a Shareholder Agreement in Texas?

What should be included in your shareholder agreement?

The answer depends on the unique needs of your company, but some common provisions are included in many shareholder agreements, including:

  • Shareholder rights and responsibilities,
  • Control of company management,
  • Restrictions on stock transfers,
  • Rights of first refusal,
  • Preemptive rights, and
  • Drags and Tags.

Stockholder Rights, Responsibilities, Limitations

In general, the shareholder agreement sets the rights, responsibilities, and limitations for each group of shareholders and how they will interact with the company, and often includes:

  • Limits on transfers of shares,
  • Details for how the company will be managed,
  • A procedure for resolving disputes between the company and shareholders,
  • A procedure for how an owner may exit the company (without litigation or the threat of dissolution),
  • A dividend policy,
  • Prerequisites for issuance of additional shares,
  • Any provisions specific to each company’s circumstances that will allow the shareholders and company to avoid unnecessary litigation while focusing on the company’s operation and profitability.

Company Management

The shareholder agreement is often used to determine who controls the company’s management.

Who manages the company? Most companies have officers (President, Chief Executive Officer (CEO), Chief Operating Officer (COO), or Chief Financial Officer (CFO)) that run the company’s day-to-day operations.

The officers, however, are chosen by the board of directors, and the board members are chosen by the shareholders. The method by which the directors are chosen is determined by the shareholder agreement.

For example, the agreement can:

  • Set the number of directors (it should be an odd number to avoid ties),
  • Specify which shareholders can appoint directors and which cannot,
  • Specify whether directors are voted on by shareholders as a group or appointed by individual shareholders,
  • Specify how many directors each shareholder may appoint, or
  • Specify the percentage of votes that will be required for different types of initiatives (for example, whether the vote will require a majority or a supermajority to pass).

Restrictions on the Sale or Transfer of Stocks

Many shareholder agreements will restrict the sale or transfer of shares except under limited circumstances that are specified in the agreement. This is useful when:

  • Shareholders want to have a say as to who else is permitted to own the company, or
  • Shareholders want to prevent unexpected shifts in power or majority shareholders.

The agreement will often prohibit any sale or transfer of shares with limited exceptions (for example, transfer of shares to a trust for estate-planning purposes).

Rights of First Refusal and Preemptive Rights

One type of restriction on the sale or transfer of shares is a “right of first refusal” (ROFR).

A ROFR protects the corporation and other shareholders by requiring a shareholder to give notice to the company and other shareholders any time there is an offer to buy their shares. The notice must inform the company and shareholders of the terms of the offer, including the price, and allow the company to purchase the shares on the same terms.

Many agreements will also grant “preemptive rights” to shareholders, requiring the company to provide notice to shareholders if the company intends to sell additional shares and allow shareholders to purchase a pro-rata share of the new stock on the same terms provided in the notice so their own share in the company is not diluted.

Drags and Tags (Drag-Along and Tag-Along Rights)

Another common provision in shareholder agreements is for drag-along or tag-along rights.

If a controlling shareholder decides to sell all their shares to a third-party buyer, a drag provision requires the minority shareholders to sell their shares at the same time.

On the other hand, you could have a tag provision that gives minority shareholders the option to sell their shares at the same time, allowing them to choose whether to stay with the company or receive a return on their investment when the company is sold.

Why You Should Have a Business Law Attorney Draft or Review Your Shareholder Agreement

Every business is unique, and shareholder agreements vary widely depending on the company’s specific needs.

If you use a “form” or “template” shareholder agreement, you will be playing by someone else’s rules that were written for someone else’s company… You should ensure that your company is governed by your rules that were written specifically for your company.

Please feel free to contact any of our Murray Lobb attorneys if you have questions regarding shareholders’ agreements, whether your company needs one, and what should be included in the agreement. We also remain available to help you with all your general business, corporate, construction, and estate planning needs.