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Why every business should use shareholder agreements

One of the worst things that can happen to a company is to have a minority shareholder who is unhappy with how the company is being run and no way to force him to sell his shares back to the company at a fair price.

This situation can foster a devastating lawsuit by an unhappy investor.

A Shareholder Agreement (also referred to as a partner buy-out agreement) can intercept this problem and give the company the right to buy-out a director or an investor.

If you don’t have an investor buy-out agreement, then there is virtually no way to eliminate an unhappy investor or partner at a fair and reasonable price.

There are numerous reasons why smart businesspeople use shareholder agreements.

As already mentioned the first and prime reason is that it provides an exit strategy. Without such an agreement the selling shareholder and the other shareholders must reach an agreement on a value of shares and stock. This is frequently a difficult task in closely held companies, particularly if the remaining shareholders have little or NO interest in purchasing the shares.

On the other hand, where a company has grown to be successful so that there is actually an outside market for the shares, the shareholder agreement allows shareholders to have control over any sales of shares to outside parties. This is done by a provision in the agreement that the shareholders have “a right of first refusal” to purchase any shares being sold, before the shares can be offered to outside sources.

Shareholder agreements can also ensure ongoing control of the company.

For instance, if a shareholder was married at the time that he gained shares in the company, the shares may be considered community property under state or Federal law. In the event that the shareholder does actual get divorced, his or her ex-spouse will have an ownership interest in one-half of the shares. A shareholder agreement has a provision that in the event of divorce; any shares held as community property by an ex-spouse MUST be sold back to the company.

Another circumstance where a shareholder agreement provides “control” to other share-holders is in the event of the death of a shareholder.

If there is no shareholder agreement in place, then the shares owned by the deceased would either be inherited by the person or persons designated in the shareholder’s will.

Or, if there is no last will and testament, the shares may be frozen by the state in probate or in a legal case involving the decease estate.

Either way, the remaining shareholders have no control over the person or persons who eventually become Co-owners of the company with them.

A Shareholders Agreements includes a provision that each shareholder agrees that in the event of death, their executor will be bound to sell the shares back to the company.

If you hold shares in a company – it is in your best interests to insist upon a Shareholders Agreement – if you don’t you are putting your investment at risk.