Short answer: A shareholder agreement sets the rules between the owners of a corporation: who makes which decisions, what happens when someone wants to sell or leaves, how shares are valued and paid for, and how disputes and deadlocks are resolved. Without one, owners fall back on the corporate statute, which rarely fits a small business.
Why a small business needs one
Most disputes between business owners are about the same few things: control, money and exits. A shareholder agreement decides those questions while everyone is getting along. In Ontario, an agreement signed by all shareholders that restricts the directors' powers is a unanimous shareholder agreement under section 108 of the Business Corporations Act, and the shareholders who take on those powers also take on the directors' duties.
Governance and decision making
- who sits on the board and how directors are nominated
- which decisions need unanimous or special approval, such as issuing shares, borrowing over a set amount, selling the business or changing the business's direction
- dividend policy and how profits are retained or paid out
- information rights and access to the books
Transfers and exits
- Right of first refusal: existing shareholders can buy before shares go to an outsider.
- Tag-along: minority owners can sell on the same terms if the majority sells.
- Drag-along: a majority can require minority owners to join a sale to a third party.
- Shotgun clause: one owner names a price and the other must buy or sell at that price. Powerful, but risky where owners have unequal resources.
Buy-sell triggers
The agreement should say what happens to a shareholder's shares on:
- death or long-term disability
- retirement or leaving the business
- termination of employment for cause
- marriage breakdown, where a spouse may claim value
- personal bankruptcy
For each trigger, set the price formula, payment terms and how the purchase is funded. Life and disability insurance owned by the corporation or the other shareholders is a common way to fund buyouts on death or disability.
Valuation
Agree in advance how shares will be valued: a formula, an agreed value updated each year, or an independent valuation. Say whether minority discounts apply. Vague valuation terms are one of the main causes of shareholder litigation.
Protecting the business
- confidentiality and assignment of intellectual property to the corporation
- non-solicitation, and non-competition where it is reasonable and enforceable
- founder share vesting, so an early departure does not take a full share of the company
- obligations to fund the business, and what happens if an owner does not
Disputes and deadlock
Equal owners need a way to break a tie. Options include a mediation then arbitration process, a casting vote, a shotgun clause or a buy-sell mechanism. Arbitration keeps disputes private and can be faster than court. Even with an agreement, shareholders keep statutory protections such as the oppression remedy.
Frequently asked questions
Is a shareholder agreement required in Ontario?
No, but without one the owners are governed only by the corporate statute and the by-laws, which rarely deal with exits, valuation or deadlock.
What is a unanimous shareholder agreement?
An agreement among all shareholders that restricts the directors' powers. The shareholders who take on those powers also take on directors' duties and liabilities.
What is a shotgun clause?
A clause that lets one owner offer to buy the other out at a stated price, and requires the other to either sell at that price or buy at that price.
When should we sign a shareholder agreement?
As early as possible, ideally when shares are first issued and before money or disagreements build up.
Can a shareholder agreement prevent a partner from competing?
It can include non-competition and non-solicitation terms, but they must be reasonable in scope, time and area to be enforceable.
Talk to our team
This guide is general information, not legal advice. For advice on your situation, see our business lawyer in Toronto page. To book a paid consultation (30 minutes, $150 plus HST, paid when you book), book online or call (647) 271-1646. The phone is answered 24 hours a day, 7 days a week, and office meetings are by appointment. Civitas Law is a team of legal professionals under the leadership of lawyer Nasibeh Mehrpouyan, serving clients in English, French, Farsi, Russian and Serbian.