It is not uncommon for entrepreneurs to overlook the importance of a shareholder agreement when establishing a new business. However, failure to have this critical agreement can cause considerable headache in the future. Simply put, a shareholder agreement is a contract to structure the relationship amongst the shareholders of a corporation. A well drafted shareholder agreement should define each party’s expectations with clear rules that describe the relationship amongst the shareholders and outline how the business should be managed.

Regardless of which type of shareholder agreement is used, the agreement can be useful for numerous purposes, best demonstrated through the use of an illustration. Consider the case of a minority shareholder wishing to exit the business and sell his or her stake in the private corporation. Shares of a private corporation are often illiquid especially in the case of a minority shareholding interest. At times, the only plausible purchaser may be the majority shareholder however, the majority shareholder may place an unrealistically low value on the interest. A shareholder agreement is able to address this problem by prescribing a fair method of valuation and a course of action to be followed upon the sale of the shares.

Furthermore, a shareholder agreement can include the following additional measures to ensure a fair outcome for all parties involved:

• Dispute Resolution: Consideration can be given as to how deadlocks amongst shareholders can be resolved. A common mechanism in a shareholder agreement is to limit the dispute resolution process to mediation or binding arbitration which is a considerably less expensive alternative than seeking restitution through the courts.

• Unanimous Shareholder Approval: In the case where one shareholder owns the majority of shares, it is important to consider whether any issues exist that should not be decided by a majority vote. A shareholder agreement can set out a class of material decisions which require unanimous shareholder approval to ensure that the majority stakeholder is not able to make unilateral decisions without first obtaining the consent of all stakeholders involved.

• Share Transfer: A shareholder’s agreement typically contains a primary rule that no shares be transferred without prior approval of the directors. This can be supplemented with a number of additional mechanisms to promote liquidity of the shares.

• Shares Transfer at time of death: a good agreement will specify how shares of a deceased partner is transferred and has a plan put in place how to fund and pay for these shares, for instance one of the better ways to fund this is by the company buying a Life insurance policy on each partner.

• Right of First Refusal: A shareholder who receives an offer from a third party to purchase his or her shares must first allow the existing shareholders the right to match such offer prior to selling to any third party. This mechanism allows the existing shareholders the option to prevent a third party purchaser from becoming a shareholder and exercising control over the corporation in the future.

• Buy/Sell or “Shot Gun” Provision: This provision allows one shareholder to offer the other shareholders a price and establish the terms under which he or she is prepared to either purchase the other shareholder’s interests or sell his or her interest to the other shareholders. It is then up to the other shareholders to decide whether they wish to either buy the offered shares or sell their own shares on the same terms and conditions presented. This provision can be very useful in the event of a shareholder dispute where the relationship between the shareholders has broken down and one party wishes to exit.