Steps to Growth Capital Self-Study GuideStep 8

8.7 Understanding the Shareholder Agreement

Many of the terms and conditions that you negotiate will be set out in the shareholder agreement. It establishes the rights of shareholders and the duties and powers of the board of directors and management. You will probably need to have a new agreement drawn up, or an existing one amended, to reflect the outcomes of the negotiations.

The shareholder agreement and, in some cases, a Debenture or Security Agreement, will cover the key issues you've negotiated: ownership restrictions to protect investment, management decision-making powers, composition of the board of directors and other issues relating to the control of the company.

A typical shareholder agreement might:

• establish rights related to the sale, issuance or subsequent distribution of shares, including rights of first refusal, piggyback rights and pre-emptive rights;
  
• define the rights and duties of the managers;
  
• stipulate options to buy or sell the shares (i.e. a "shotgun clause");
  
• anticipate what will happen in case of death, retirement, etc., of a shareholder (the agreement should set out whether, in the case of such events, the value of the shares is to be calculated according to a predetermined formula and if the minority position of the shares in question should be considered); and
  
• establish the composition and duties of the board of directors.

The shareholder agreement may also:

• provide existing shareholders with the right to approve future shareholders; and
  
• document any exit mechanism that has been negotiated.

You'll Need Legal Help

As with any contract, legal assistance is essential for your own protection. Because of different circumstances for each business relationship, a standard or off-the-shelf shareholder agreement won't be appropriate to your circumstances. You'll have to craft a custom agreement to fit your specific needs and arrangements. An effective agreement can't be prepared without the help of an expert.

Make sure that the shareholder agreement clearly documents the intentions of the shareholders. Relationships among shareholders can and do change. Intentions and facts that are clearly agreed to by shareholders today may become areas of future dispute if they aren't properly documented.

Know more on the main components of a typical shareholder agreement.

Debenture or Security Agreement

If an investor makes a subordinated debt investment in your business, there will usually also be a requirement for a debenture or security agreement. Key elements of this agreement may include:

• principal amount;
  
• interest rate;
  
• term of loan;
  
• principal repayment;
  
• security;
  
• financial covenants;
  
• activities requiring investor's consent; and
  
• reporting.

This list is based on: Torkin, Manes, Cohen and Arbus, "Legal Components of Venture Capital Financing" a presentation by Mr. Barry S. Arbus, Q.C., February 13, 1997.

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