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What's the Purpose of a Shareholders' Agreement

Anticipating issues or problems before they develop can help avoid litigation or the breakup of a business.

Whenever you are partnering up with others, you are well advised to have an agreement with your business associates. Small Corporations or Limited Liability Companies – particularly those with two to five shareholders (partners) who are active in the business – should enter into an agreement amongst themselves to deal with a variety of issues which often arise in the operation of a business. These types of agreements are often referred to as Shareholder Agreements and are designed to help ownership deal with a variety of issues which arise in the course of any business’s development. Not only can these Agreements govern the actions of the business, but also the rights and duties of the partners.

For example, a simple mandatory mediation provision in the agreement can help avoid costly litigation or resolve disputes that could jeopardize the success of the business.

Illinois has a strong history of upholding shareholders’ agreements pursuant to the underlying policy regarding freedom of contract. In Galler v. Galler, 32 Ill.2d 16 (1964), the Illinois Supreme Court recognized that shareholder agreements offer a practical and necessary protection for owners of small businesses. This includes both the majority and minority owners of a small business. Shareholders can contract amongst themselves to cover any number of events.

Purposes of a Shareholders' Agreement

A shareholders’ agreement may be appropriate to address all or any combination of the following subjects and purposes:

  • To identify or limit who may become a shareholder and who may or must remain as a shareholder.
  • To preserve a shareholder’s proportionate interest in relation to the holdings of other shareholders- i.e., if one shareholder chooses to or is compelled to sell shares, the remaining shareholders may want the right to purchase the seller’s shares in proportion to their shareholdings.
  • To preserve a shareholder’s proportion of the outstanding shares- e.g., to give the equivalent of preemptive rights to the shareholder parties to the agreement (who may include less than all of the shareholders).
  • To place restrictions on the sale or other transfer of shares.
  • To control voting rights among the shareholders and to otherwise provide for the management of the corporation. Instead of a simple majority, it might be wise to require a higher majority to take certain actions like borrowing money or making capital investments.
  • To assure that the corporation and/or the remaining shareholders may acquire a shareholder’s shares under certain triggering circumstances- e.g., death, disability, divorce or termination of employment by the corporation.
  • To provide liquidity and to assure an exit strategy so that a shareholder’s investment may be sold under certain triggering circumstances- e.g., death, disability or termination of employment.
  • To determine management and other governance arrangements, including the allocation between the Board and the shareholders of the authority to determine certain issues.
  • To plan for succession of ownership and management responsibilities.
  • To provide a mechanism for resolving disputes or management deadlocks such as mediation or arbitration to avoid costly litigation.
  • To provide for dividends and other distributions.
  • To give minority shareholders a “tag-along” or “co-sale” right to participate in any sale of shares by a shareholder or group holding a major interest in the corporation.
  • To give a majority shareholder or group a “drag-along” (or less bluntly called a “bring-along”) right by which they can compel minority shareholders to participate in share sale transactions that the majority negotiates, so that the majority can deliver all of the shares in a sale (or at least all of the shares covered by the agreement).
  • Providing non-competition or non-solicitation provisions to prevent partners from taking business away.
  • Protecting Trade Secrets.

The Chicago business lawyers of Bellas & Wachowski are available to help you with any questions you may have regarding shareholders agreements.

Buy-Sell Agreements

Many shareholders’ agreements have arrangements relating to the purchase and sale of shares under defined circumstances. These “buy/sell” arrangements restrict the transfer of shareholder interests upon certain triggering events. Such arrangements are often drafted in consideration of maintaining harmonious relationships between shareholders, who are often managers of the corporation. Additionally, certain estate planning objectives should be considered when drafting such restrictions.

The buy/sell arrangements may be mandatory on seller and buyer(s) if a triggering event occurs, or the triggering event may give rise to an option to buy or sell.

The corporation itself may have the right or obligation to purchase shares, and/or such rights and obligations may be allocated to other shareholders.

There are basically three types of “buy-sell” agreements:

  • Redemption Agreements
  • Cross Purchase Agreements
  • Hybrid Arrangements

The determination of which agreement is best for your particular business and interests requires a careful analysis of the goals of the agreement, valuation of the business, and the finances necessary to implement any type of buy-sell agreement.

Valuation of Interests

A significant benefit of a shareholders’ agreement is to either set the value of a shareholders’ interests or to establish a method of valuation. The important thing is to remove a lot of the uncertainty in the valuation of the shareholders’ interests in the event of the death of a shareholder or if a shareholder withdraws from the business. Valuing the interests for the buy-sell can be done several ways:

  • Fixed Price that is periodically reviewed
  • Setting a formula based on several factors
  • Appraisals from experts
Prepare in Advance for Problems or Breakups

A shareholder’s agreement can function much like a pre-nuptial agreement in a marriage. It can avoid a lot of the uncertainty in entering into a relationship and minimize the problems that arise when partners break up.

The Chicago Business Lawyers of Bellas & Wachowski are uniquely experienced in establishing businesses and have dealt with many disputes between business owners. We encourage our business clients to establish a trusting relationship with trusted business advisers who can help guide a business from the startup phase, through growth, into preservation and the inevitable breakup. Our first goal is to discourage litigation and we seek every means of avoiding conflict. Our success record speaks for itself.

If you would like to discuss your business’s unique situation, contact George Bellas (847.823.9032 or george@bellas-wachowski.com) for a consultation.

Bellas & Wachowski Attorneys at Law
15 North Northwest Highway
Park Ridge, Illinois 60068
The In-House Counsel for Small Businesses™