Hello, I’m Sabrina, one of the lawyers at Varity Law. Recently, my legal team and I drafted various types of shareholder agreements for our clients starting new businesses. This agreement is crucial when you have more than one shareholder within your company, as it can avoid costly litigation and stalemate in business operations later on.
A common misunderstanding is that only those few shareholders who are very aggressive, disagreeable, and litigious need this contract. In reality, all companies with more than one shareholder should have their shareholder agreement done during or shortly after incorporation.
This ensures that all shareholders agree to one set of rules regarding:
- How decisions are made in the business
- How is money divided amongst them
- What happens if any shareholders leave the company, whether voluntarily or involuntarily?
Essentially, spending just a thousand or two to draft this contract will avoid at least tens of thousands of dollars down the line.
Now that we understand the need for this agreement, what are the essential shareholder agreement clauses that should be included?
Shareholder Agreement Clauses that Determine How Decisions are Made in the Business
Are YOU a shareholder with any say in how the business should operate?
First, a shareholder agreement, in combination with the corporate minute book, should clearly list who are the current shareholders. This information is often not found on your government-registered articles of incorporation.
Many clients ask me, but what about future shareholders? We always include a clause in the agreement that states any future shareholders who choose to subscribe to shares will be given the opportunity to review the shareholder agreement. If they do not object to the agreement within a certain number of days, then it’s considered that they agree to it, without having to sign it.
Thus, before you decide to purchase shares and join a corporation, you should always check with the existing shareholders to see if there is already a shareholder agreement in place. When you receive your share certificates, the certificate should include a phrase stating that by agreeing to purchase the shares, you agree to be bound by the existing shareholder agreement.
How much say do you have as a shareholder?
How decisions are made within a company is very important and should be specified in the agreement. Directors are the ones who make most day-to-day decisions, like deposits and withdrawals into the business bank account.
In contrast, shareholders, who are the owners of the corporation, make decisions relevant to the shares themselves. For example, what are the share classes? A typical example is that some shareholders hold voting shares, meaning they can choose who the directors are, while other shareholders hold preferred shares with no voting rights, meaning they can only invest in the company and receive dividend returns. They cannot make any decisions regarding how the company operates.
Also, the shareholder agreement should clearly state how much % of shares is considered a majority. Only when a majority of shareholders agree on an issue can their decision be passed. For example, let’s say the agreement and minute book set the shareholder majority as 75%, and the company has four voting shareholders, each holding 25% of the shares issued. This means that at least three out of four shareholders must agree on an issue for the decision to be passed. If the company has any preferred shareholders with no voting rights, then they cannot participate in decision-making.
Shareholder Agreement Clauses that Determine How money is divided amongst shareholders
How can shareholders legally withdraw money from the company?
The most common way for shareholders to take money out of the company is by issuing salaries or dividends.
Salary means that the shareholder is also an employee of the company. Thus, any money they take out would be subject to income taxes and payroll deductions. Like employees, the payroll deductions is directly deducted from their income, and they receive the net income after this deduction. Essentially, they are paying income taxes immediately.
A dividend means that the shareholder is getting a return on their investment from the company. Unlike salary, income taxes on dividends are usually paid later in the following year, when the shareholders file their tax returns. For example, if the company’s financial year-end is December 31st, then the shareholders who received dividends in 2025 would file and pay for income taxes on those dividends on or before April 2026. Basically, they are paying income taxes later.
If you are wondering whether it’s more profitable to take out a salary or a dividend for tax purposes, please consult a business accountant.
Must shareholders make financial contributions to the company?
Shareholders usually do not have any obligations to put money into the corporation, unless it’s specifically required in the shareholder agreement. There are two ways in which the shareholders can invest in the corporation.
First, they can simply buy more shares. The price per share should be routinely determined and updated by the directors of the corporation and agreed to by a majority of directors and shareholders during their meetings. Unless otherwise stated in the agreement, any shareholder investments in the company are not protected. In other words, if the corporation loses the money, then the shareholders lose their investment.
Second, shareholders can lend money to the company and become creditors. But again, if the loans are not secured by collateral like real estate, the shareholders may be unable to recover their loans if the corporation performs poorly.
What happens when a shareholder tries to sell their shares?
A significant issue is whether existing shareholders can sell their shares to anyone they choose. If they can, then the shareholders who remain in the corporation would have to run it with a stranger. For example, let’s say Amy and Sam started a company together, and they are both voting shareholders. Amy decided to sell all her shares to George, without Sam’s agreement. Now, Sam has to run the company with George, who is a stranger to him. To prevent this, it’s essential to have share transfer restrictions in the minute book and in the shareholder agreement. That would prevent Amy from doing this.
Of course, the corporation cannot just be in a stalemate. So, if there are share transfer restrictions, the agreement must clearly say what happens if Amy wants to sell her shares, but Sam does not agree.
A common solution is requiring any selling shareholders to offer their shares to the existing shareholders first. This means that Amy would need to make an offer to Sam to sell her shares, before she can offer it to outside strangers. The opposite can also be done. The shareholder agreement can include a shotgun clause where Amy can offer buy all the shares held by Sam. This way, she can have the company all to herself.
What happens if a shareholder wants to leave the company?
Voluntarily Leave and Non-Compete Clauses
Often, when a shareholder leaves a company, the other shareholders remaining in the corporation do not want to see that person start a new shop elsewhere and become their new competitor. To prevent that, they can include a non-compete clause in the agreement.
To be enforceable in Court, this clause should be limited in time, distance, and business type. For instance, if Amy and Sam’s company specialized in selling coffee, then a reasonable non-compete clause could be, when Amy leaves the corporation, she cannot start a coffee shop within 10 kms of the corporation for the next 5 years. In contrast, an overly restrictive non-compete clause would say Amy cannot start any food and beverage-related business within Ontario for the next 20 years.
Additionally, we can include a non-solicitation clause in the shareholder agreement, which would prevent Amy from approaching the corporation’s existing employees and clients in an attempt to solicit them away.
But do be careful here. Employees and clients have their own free will and should not be considered as commodities owned by the corporation. If they decide to leave with Amy out of their own free will, without her having approached them, then the non-solicitation clause may not apply.
When shareholders pass away
Unfortunately, in our experience, this happens more often than people think. When a shareholder passes away, the company must have a quick way to settle their shares so it can continue to operate smoothly.
The shares of the deceased shareholders would be passed down according to their Will, or if they did not make a Will, according to estate legislation, which prioritizes their spouse and children. Now, if the deceased shareholder holds voting shares, their beneficiaries can inherit those shares and have a say in the company. This then results in the same problem as when there are no share transfer restrictions – the existing shareholders may need to run the business with relatives of the deceased shareholder, who may be uncooperative strangers.
To avoid this, the shareholder agreement can require the beneficiaries to sell back the deceased’s shares to the company and not give them the option of becoming voting shareholders. Of course, this means that the business needs to have enough liquid funds to buy the beneficiaries out. This can be achieved if the company had bought life insurance for the deceased shareholder, or the agreement allows the company to make installment payments to the beneficiaries.
Conclusion
When a corporation has more than one shareholder, it should set up a shareholder agreement immediately, at a time when the shareholders are still agreeable to each other and are all willing to sign.
This will avoid costly litigation and business stalemate in the future. Some essential clauses to include in the shareholder agreement include how decisions are made together (who are the shareholders and how much say they have), how money would be split amongst shareholders, and how to keep the business in smooth operations should a shareholder leave the company, whether voluntarily or involuntarily by passing away.
We encourage all business owners who do not have a shareholder agreement in place to book a 1st free consultation with us here: https://calendly.com/sabrina-668/1stfreeconsult
