EQUIVESTO COMPANY BOOTCAMP

Shareholders’ Agreements

 At their simplest, corporations are controlled by their owners (shareholders).  To make decisions about the business, shareholders would get together (a Shareholders Meeting) and vote (a Shareholder Vote) on what to do.  In these simple scenarios, one share equals one vote, and majority vote wins.  When a business is first incorporated with only one founder (who is also the only director), there are often no additional rules created around how the founder controls the business.  Since the founder is the sole shareholder and owns 100% of shares, every decision they make is a shareholder vote, and each vote is unanimous.  

When opening the corporation to other investors, it doesn’t make sense to call a shareholders meeting every time a simple decision is required.  It is also important to officially acknowledge what roles, responsibilities, and rights each investor (including the founder) has with relation to the corporation.  To clarify all this, corporations create a Shareholders’ Agreement.  This agreement can be as simple or as complex as the corporation requires.  

Shareholders’ Agreement

Even the simplest shareholders’ agreement often includes rules around the following:

  • Shareholder Details

    • Who are the shareholders (and how many shares do they have)

    • What roles do each shareholder have (President, Secretary)

    • How often do the shareholders meet

  • Director Details

    • Who are the Directors of the Corporation and who can choose them

    • How often do the Directors meet

  • Control of the Corporation

    • What decisions can the Directors make

    • Which decisions require a shareholder vote

    • Who can sign documents on behalf of the corporation

    • Who can hire and fire employees

    • Where is the business location

    • What type of business does the corporation do

    • Who keeps track of the accounting/finances

  • Dealing with Shares

    • Can shareholders give their shares to other people (family members etc.)

    • What happens if a shareholder gets divorced

    • How and when can a shareholder sell their shares

  • Sale of the Business

    • What happens if someone wants to buy the business

    • How to set the valuation of the business

  • Legal Protections

    • Do shareholders agree not to sue the corporation

    • Is the business of the corporation confidential

    • Can a shareholder start a competing business

    • Protections for minority shareholders (shareholders who own less than 50% of the shares)

These agreements are critical in outlining how the business makes decisions and who has power to do what.  It is critical that business founders understand the details of their shareholders’ agreement, as this will dictate how they propose to manage and govern their business moving forward.  

Check out a free template of a shareholders agreement here.

Directors of a Corporation

As noted above, a Director is an individual chosen (usually an existing shareholder) to oversee the corporation’s business and strategic goals.  Corporations must have at least one director.  Directors are chosen by the shareholders of the corporation, through a shareholder vote.  Together the Directors (Board of Directors) work to control the corporation and manage its strategic, long term decisions.  The Board of Directors is also responsible for hiring the Chief Executive Officer (CEO) who controls the day to day operations of the business. In a small business, the founder might be the only shareholder, the sole director, and the CEO all at once.   

The power and responsibilities of the Board of Directors are defined in the Shareholders’ Agreement.  That document outlines which decisions are made by the Board of Directors, and which must be sent to a full shareholder vote.  The Shareholders’ Agreement also outlines how the Directors are selected, and how many Directors the corporation will have at one time.  

Choosing your Board of Directors is important.  Many key decisions of the company can be left up to the Board of Directors (depending on the Shareholders’ Agreement) and each Board member gets their own vote, out of the total number of Board members.  

Even if you own 80% of the company as a shareholder, if your Board has 3 Directors, and you are only one of them, the other two Directors can easily out-vote you on Board level decisions.  

Often, when seeking external investment from a large investor, they will require that they have the right to choose at least one Director of the corporation.  This would allow the new, large investor to participate in Board of Directors meetings and cast votes on the decisions made by the Board. 

Making Corporate Decisions

An important aspect of the Shareholders’ Agreement are the sections controlling decision making and specifically the split between Board of Directors level decisions and Shareholder Vote level decisions.  

Decisions like hiring and firing employees, buying assets, expanding to new markets, taking on loans, choosing salaries, and issuing dividends (payouts of company profits to shareholders) can all be made at either the Board level or the Shareholder Level. 

When taking on new investors and allowing new Board members, many founders feel that putting critical decisions to a Shareholder vote, as opposed to at the Board level (where they only have one vote out of 3) allows them to keep greater control of their business.  This is true; however, this can also lead to more frequent shareholder meetings and more paperwork.  If a corporation has many shareholders, each shareholder needs to be invited to the shareholders’ meeting and given adequate notice so they can attend. 

With equity crowdfunding, many companies find it easier to move many decisions to the Board level, keeping only the most critical at the Shareholder level.  This allows the smaller Board of Directors to meet more frequently and move quicker when managing the corporation and responding to any timely issues.  

That way, shareholder meetings are called as infrequently as possible (at least 1 per year required) which makes it easier when organizing for hundreds of investors to potentially attend if they so choose.  

Share Types and Share Classes

Shares issued by corporations are often divided into two types, Common Shares and Preferred Shares. 

Common shares are the most basic, standard shares.  They do not have any special rights assigned to them and are often the shares held by founders and initial investors.  Common shares often include voting rights, and as such, common shareholders have the ability to vote at shareholders meetings and decide the decisions of the company.  

Preferred shares differentiate themselves from Common shares in two key areas.  Preferred shares often do not have voting rights, so the holders cannot vote at shareholder meetings and help decide the direction or decisions of the company.  Preferred shares also often include special rights which provide them dividends (annual payments to shareholders out of that year’s company profits).  

Of those two types of shares, companies can issue special or unique versions that have specific rights the company creates.  This ability allows companies to create unique control structures and shares to suit the requirements of their investors that are different from those of other companies.

Many companies raise capital with equity crowdfunding issue Non-Voting Common Shares.  These shares give their holders the same rights as other common shareholders, excluding the right to vote.  This allows individuals to invest in the business and share in potential returns but ensure the voting (and thus the control) of the business remains in the hands of the original founders and existing shareholders.  This often makes sense when you are accepting investment from hundreds of small investors who are investing as little as $100 in your business.