The Importance of Your Shareholder Agreement

Having in place a shareholder agreement that you have read and understand is a best practice we advise for every family business. A shareholder agreement codifies the mechanics of ownership. It is a legally enforceable document. Without one in effect, your shareholder agreement is whatever the laws in your jurisdiction prescribe, which may not be at all what you want. (For more information, see Is Your Company’s Strategy Aligned with Your Ownership Model?) For example, some places give judges the right to initiate the sale of a business if the owners are in a stalemate. If you have a shareholder agreement but have not read it lately, pick it up and make sure you understand its implications. A shareholder agreement typically does the following:

• Clarifies ownership’s decision-making authority, that is, who makes what decisions, what the decision rules are (majority, supermajority, unanimity), and what ownership percentages constitute the majority
• Places restrictions on the transfer of ownership, such as prohibiting nondescendants from being owners
• Establishes the rules by which shares can be bought or sold, including who has the right of first refusal if someone wants to sell and whether owners have a right to “put” their shares to the company (i.e., to sell their shares under specified terms)
• Specifies any situations in which ownership must be redeemed, such as when an owner violates the terms of the shareholder agreement or is convicted of a crime
• Gives minority or majority shareholders certain rights, such as tagalong and drag-along rights, in a sale of the business
• Determines share valuation methodology for various situations

If you don’t have a shareholder agreement, start working on one as soon as possible.

*Adapted from the Harvard Business Review Family Business Handbook by Josh Baron and Rob Lachenauer. Pages 72-74