Emergence hosts Seminar on “Shareholders’ Agreements” with Legal Partner, McInnes Cooper

All shareholders – whether in a start-up, a small venture, or a large business – can benefit from a shareholders’ agreement.

new-mcinnes-cooper-logo-300-dpi-mediumFor example, a shareholders’ agreement will need to be drafted, negotiated and finalized – in many cases – before an investor will even cut a cheque!

A shareholders’ agreement is designed to address potentially contentious issues – before problems arise!

To address these issues, Emergence, together with our Legal Partner, McInnes Cooper, recently held a workshop for early-stage ventures to help them better understand the key practical considerations and terms of founders shareholders’ agreements, as well as the key complementary agreements to consider.

A shareholders’ agreement – as participants learnt – defines the relationship, rights and obligations between the shareholders and the company. It documents their agreement on matters related to the company’s management and operation, financing, organization and the transfer of shares.

Some of the key considerations for shareholders’ agreements that were discussed include:

Timing. Deciding when to spend the money to put a shareholders’ agreement in place isn’t easy. Paying for one too early could be a waste of money if the business plan isn’t fleshed out or the co-founders aren’t yet decided. However, investors will likely want to see one in place before they consider financing the company. And expect investors, especially active ones, to want to discuss modifying the agreement to give them board participation and other things.

Minority Shareholder Rights. The legal framework is designed to protect minority shareholders. So just because a shareholder owns more than 50% of its company doesn’t mean it can make decisions that disregard the interests of minority shareholders.

Independent Legal Advice. Shareholders’ agreements have long-term ramifications. Each co-founder must understand the terms of the agreement and obtain independent legal advice to make sure they do.

In addition, participants learnt more about some of the key terms of a founders’ shareholder agreement. These include:

  • Appointment of Board of Directors.
  • Restriction on Director Powers. These agreements will generally remove director powers and place in the control of shareholders.
  • Distribution of Profits. If shareholders have certain expectations about dividends or other payouts, the agreement should set them out.
  • Meeting Procedures. Deal with the procedure at shareholder meetings, in particular for meeting quorums.
  • Special Approvals. It’s also helpful to require a higher level of shareholder approval (higher than a majority, such as three-quarters, two-thirds, or unanimous) for certain fundamental changes such as: the sale of assets outside the ordinary course of business, change of business, borrowing in excess of certain amounts, major capital expenditures, amalgamations, winding-up and revising the company’s articles.

Also discussed were:

Pre-Emptive Rights. This right allows each existing shareholder to avoid dilution of her ownership stake in the company.

Rights of First Refusal. Rights of first refusal provisions (ROFRs) protect shareholders – but tend to deter third party purchasers, because the process is complicated. There are two variations of an ROFR.

  • “Hard” ROFR. This is a right of first option: it requires a shareholder(s) to receive a bona fide offer from a third party before offering the shares to other shareholders on the same price and terms.
  • “Soft” ROFR. This is really a right of first offer: it permits a shareholder to sell her shares to a third party after offering them to the other shareholders.

A right of first refusal may include special rights for majority and/or minority shareholders when a third party wants to enter the mix.

  • Tag-Along Rights. This allows other shareholders to “tag-along” with the shareholder that’s selling to the third party.
  • Drag-Along Right. If a third party offers to buy the controlling shareholder’s shares (however the agreement defines the controlling shareholder), the drag-along right allows the controlling shareholder to force all other shareholders to either: sell their shares; or approve the resulting change of corporate control.

Put/Call Provisions. The agreement usually sets out circumstances that “trigger” put or call options: circumstances in which shareholders may acquire each other’s shares, usually at fair market value or possibly at a discount in certain circumstances.

Shotguns. A shotgun clause is intended to break a deadlock between shareholders. There are both single shareholder shotguns and multiple shareholder shotguns!

Share Valuation. It’s important the agreement addresses share valuation. There are two main approaches to valuation.

  • Business Valuation. The company is valued by an independent business valuator according to the terms of valuation set out in the agreement.
  • Fixed Formula. This could be specified as a multiple of corporate earnings, the book value of the company’s assets, or another established method of pre-revenue business valuation.

Other Provisions. Shareholder agreements typically also include additional provisions that address other key aspects of the business.

  • Provision for the company’s accounting, including preparation of the company’s financial statements & budgets.
  • Indemnity and insurance issues.
  • Shareholder duties and compensation.
  • Signing authority for banking and contracts.
  • Alternative Dispute Resolution mechanisms for shareholder disputes (e.g. requiring negotiation and/or mediation before litigation).
  • “Boilerplate” provisions such as entire agreement and severability clauses.
  • Acknowledgement the shareholder has had the opportunity to seek and obtain independent legal advice (ILA).

KEY COMPLEMENTARY AGREEMENTS

Here are additional agreements between the company and its shareholders beneficial to both a start-up company and its shareholders.

Reverse Vesting Agreements. This agreement between co-founders is, in effect, a “company repurchase option” under which the company agrees to buy back a co-founder’s shares for a nominal amount. There are particular considerations in the case of Founder Reverse Vesting Agreements:

  • Cliff. Decide whether a cliff is needed for founders, and if so, get it right. If a co-founder doesn’t reach the cliff, the company can re-purchase all that co-founder’s shares for a nominal amount leaving that co-founder with no equity. If the co-founders have been working with the company for a significant time before putting a vesting agreement in place, they might not need a cliff at all.
  • Vesting Period. Getting the vesting period right: from what date does it run, and for how long. Companies will typically use a two to four year vesting period. Be particularly careful with terminations: if any co-founder is terminated during the vesting period without cause, these typically agreements provide that the shares immediately vest in full.

Proprietary Information and Inventions Agreement. This agreement protects the company’s proprietary information by ensuring the company retains ownership of sensitive information and intellectual property (including inventions) by setting out the shareholder’s confidentiality and non-disclosure obligations along with the company’s recourse in the event of a breach.

Employment Agreement. It’s wise practice for the company to enter into a written employment contract with each employee – including the co-founders and any other shareholders who are employees.

Employee Stock Option Plan (ESOP). If there is such a plan, it’s critical to document it and enter into an agreement setting out its terms and conditions.

About McInnes Cooper
McInnes Cooper is among the top 20 largest business law firms in Canada and offers an elite team of highly qualified lawyers for this mandate. Each year, McInnes Cooper lawyers receive recognition for their leadership and contributions to the legal professional. Eighty-nine (89) McInnes Cooper lawyers are celebrated as leading lawyers in the 2017 Canadian Lexpert Legal Directory. The Firm’s lawyers are also featured prominently in Best Lawyers in Canada and other leading publications. We are proud to count McInnes Cooper among our Partners at the Emergence Incubator.

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