What is a Shareholders' Agreement? What to Include and What to Watch For
A shareholders agreement is the private constitution of your corporation. Unlike the articles of incorporation, it stays confidential. Unlike a handshake, it is enforceable. Here is what every clause means.
What is a Shareholders Agreement?
A shareholders agreement (SHA) is a contract among some or all of the shareholders of a corporation and often the corporation itself that governs the relationship between them. It supplements and can override the default rules set out in corporate legislation. It answers questions the law leaves unanswered: What happens if a founder wants to leave? What if there is a deadlock? Who can become a shareholder?
Why You Need One
Without an SHA, you are bound by the default rules of the OBCA or CBCA rules designed for generic situations, not the specific dynamics of your business. A founder who leaves after six months without vesting provisions may walk away with a large equity stake and no obligation to continue. A minority shareholder with no drag-along protection can block an acquisition indefinitely. An SHA prevents these outcomes.
Key Provisions Every SHA Should Include
Vesting Schedule
Founders earn their equity over time rather than all at once. A typical schedule is four years with a one-year cliff if a founder leaves before the cliff, they receive nothing; after the cliff, they vest ratably each month. Protects the company if someone exits early.
Right of First Refusal (ROFR)
Requires a selling shareholder to offer their shares to existing shareholders at the same price before selling to an outsider. Controls who can become a shareholder.
Drag-Along and Tag-Along Rights
Drag-along allows majority shareholders to force minorities to sell in an acquisition. Tag-along allows minorities to join a controlling sale on the same terms. Both are essential for a balanced SHA. See the dedicated Drag-Along, Tag-Along and ROFR article for full detail.
Shotgun / Buy-Sell Clause
A deadlock-breaking mechanism: one shareholder names a price and either buys the other out at that price or sells to the other at that price. Forces parties to name a fair price since they do not know which side they will be on.
Board Composition and Voting
Who appoints directors? What decisions require unanimity or a supermajority? Can certain financing or major transactions be approved by the board alone? Critical governance rules for multi-founder companies.
Non-Competition and Non-Solicitation
Post-departure restrictions preventing former shareholders from competing or soliciting clients and employees. Must be reasonable in scope, geography, and duration to be enforceable. Note the 2021 Ontario restrictions on employment non-competes.
What to Watch For
Red flags in a shareholders agreement:
- No vesting provisions someone can contribute minimally and hold equity indefinitely
- Drag-along without proportionate tag-along protections for minority
- Ambiguous valuation mechanisms creates disputes every time they are invoked
- Overly broad non-competes that may be unenforceable
- No dispute resolution clause leaves parties to litigation by default
- SHA provisions that contradict the Articles of Incorporation