Legal Watch: Shareholder Agreements

Nov. 10, 2015
How to address a wide range of possible issues that may occur during the life of your company

A shareholder agreement for a corporation or an operating agreement for a limited liability company (LLC) is a vital document for partners entering into business (in this article, I use the term “shareholder agreement” to generically refer to a corporate shareholder agreement and an LLC operating agreement).

Too often though, business partners do not enter into a shareholder agreement at the outset of their venture — and the consequences can be disastrous. If you have not dealt with important issues on the front end, things can be much more expensive on the back end. Like the old Midas commercial, you can pay now (to prepare and guide you through the shareholder agreement) or pay later (to extricate you from the situation that arises without an agreement).

Why They are Important

A shareholders agreement is the roadmap to governing the company and the relations between its shareholders (or “members” in an LLC). A well-written agreement addresses a wide range of possible issues that may occur during the life of the company. For example, what happens if a shareholder dies? Who gets paid what amount, when and by whom? Where do the deceased’s shares go? What if a shareholder suddenly decides they no longer want to help create RMR, they want to practice yoga at an ashram in the Berkshires? Can a shareholder leave the company and freely compete with her former partners? How do you value a member’s equity interests in the company? Who gets to decide these issues in the event of a dispute? And what happens if the partners are unable to agree how to run the business?

If you do not answer these sorts of questions in a comprehensive manner in the present, you are leaving the law to fill in the gaps in the future — which probably will not be optimal.

If you do not deal with these issues up front, it can get ugly, frustrating and expensive — especially if you are one of the remaining partners who entered into the deal with the understanding that the departing shareholder would pull their weight with the rest of the shareholders. If you don’t set up a process to address these sorts of issues when entering into the relationship, you will likely to be headed to court if you have to force the issue. You do not want that expense or headache; plus, you leave it to the court to decide what is appropriate.

Get Help

Make sure you retain competent legal counsel to guide you through this process. Pick a knowledgeable business lawyer, not someone who spends their time in criminal court or drafting wills. This is an area of the law where it pays to have experience preparing these sorts of agreements and experience dealing with issues that crop up down the road.

A good lawyer will make you aware of the inherent conflict of interest that arises in this process — who does the lawyer represent? The company? You? Your partners? All of the above? If each partner chooses not to invest in their own counsel, understand that the single lawyer cannot favor one partner over the other and, therefore, will not be able to provide any of you truly independent advice and guidance. Rather, in those circumstances the lawyer will be limited to presenting the issue and the possible resolutions. The attorney will not be able to advocate for one position (or one partner) over the other. The rest will be up to you.

A business partnership is a lot like a marriage. No one wants to deal with the heavy issues at the beginning of the relationship — especially when love is in bloom. In a business marriage, you are best to cool your ardor and figure out how you and your partner (or partners) want to deal with a wide range of possible issues should they arise.

Negotiate the agreement sensibly and then put it away in your desk drawer. With any luck, you’ll never need to look at it again; however, if you do, you will likely be relieved to have already dealt with the nitty-gritty.

Eric Pritchard is a Philadelphia lawyer who spends his workday making the world safe for electronic security providers. Reach him at [email protected]. This column does not constitute legal advice; contact an attorney with questions. 

About the Author

Eric Pritchard | Eric Pritchard

Eric Pritchard is a partner in FisherBroyles, a law firm with office throughout the United States and in London. He spends his days trying to make the world safer for the security industry. You can reach Eric at [email protected].