Why Have a Shareholder and Partnership Agreement?
Even shareholders and partners who get along well should have a written agreement. Shareholder and Partnership Agreements are drafted prior to the time that disputes or other unexpected situations arise. They contemplate a fair and reasonable way to resolve issues, and they provide to shareholders and partners the opportunity to discuss their plans, goals, and expectations for the business. They also can save time, energy, and cost.
Have you considered what you would do if your partner died or became bankrupt? What would you do if your partner became involved in a contentious divorce? When do you plan to retire, and how will you exit the business? How will you raise funds if you need more money to operate the business? When and how will you and your partner take money out of the business for personal use?
Who Needs an Agreement?
Any person who is going into or is already in business with another person should have a Shareholder or Partnership Agreement, regardless of how well the parties know and like each other.
What issues should an Agreement Address?
- Who will have the power to make decisions, and who will be responsible for day to day management;
- Who has banking authority;
- Whether the parties to the Agreement will be employees;
- Actions that require unanimous approval of all of the parties including: (a) sale or mortgage of property; (b) issuance of more shares or partnership interests; and (c) termination of the employment of any of the parties;
- Method of transfer of shares or partnership interests, including: (a) Restrictions on Transfer – no party would be able to transfer his or her interest without first offering to sell it to the other party or parties; (b) Tag-along rights – where a party who owns a greater than 50% interest in the business receives a offer from a third party purchaser, the other parties have the right to require the third party to purchase their interests in the business; (c) Drag-along rights – where a party who owns a greater than 50% interest in the business receives an offer from a third party purchaser, the party has the right to require the other parties to sell their interests in the business; and, (d) Shot gun provisions – allows a party to give notice to the other party setting out the terms and price for the sale of that party’s interest in the business. The party receiving notice must either elect to buy, or must sell all of his or her interest on the terms and price in the notice. This clause may be important if the parties have a dispute that they cannot settle;
- How the parties will get a return on their investment in the business;
- Events which are considered a default under the Agreement and which will require a party to sell his or her interest in the business, including: (a) breach of the Agreement; (b) disability or incapacity; (c) separation or divorce; and, (d) bankruptcy.
- Provisions for dealing with the death of a party;
- Method for determining fair market value of the parties’ interests in the business;
- Mechanisms for dispute resolution.
Can I Cut and Paste My Own Agreement?
The Internet is a powerful resource for finding information, including obtaining copies of contracts that have been used by others. However, every business is different, and the agreement will need to address the needs of the business, as well as the specific needs and interests of each of the parties. For example:
- Where a standard form agreement may provide that one partner buy the interest of the other partner for the value of that partner’s interest in the business as at the date of death, and where the business is a bed and breakfast located in a ski resort town, the surviving partner would receive a windfall if the deceased partner died in July. The parties would likely want to discuss with their accountant a fair way to determine value, which would take into account the seasonal fluctuations of the business.
- A standard form agreement drafted on the understanding that the partners or shareholders are companies, would not be appropriate for a business in which the partners or shareholders are individuals.
- A standard form of agreement may not take into account the different expertise that each partner offers to the business. For example, if two parties open a restaurant together, one may be the chef and the other may handle the marketing and finances. The success of the business depends on each party committing the time to fulfill their role, and the agreement should specify this requirement. It should also put the party in default of the agreement if that party fails to fulfill that role.
Not only is it important to tailor the agreement to the individual needs of the parties, it is also crucial that the parties understand their rights, interests, and obligations. It is not sufficient simply to have an agreement. Instead the agreement must be a useful tool for managing the business.
A successful business requires planning. In addition to marketing, financial planning, and developing a business plan, partners should sit down and discuss what they want for the business and what each partner’s role in the business will be. Although there is an initial cost to setting out the terms in writing, it is a small cost compared to the time and expense that could result if something unexpected were to happen and there was no plan in place.
If you would like more information or require legal advice regarding directors liability, please contact one of the lawyers in our business law group.