Shareholders’ agreement

A shareholders’ agreement is one of the most important documents for a corporation. It’s a private contract that outlines the rights and responsibilities of its shareholders and establishes safeguards that help protect both the shareholder and the corporation. It supplements the articles of incorporation, also known as the charter. That’s the legally required document that formally establishes the corporation. Those articles set out the corporation’s basic legal framework and, importantly, the share structure establishing the rights and restrictions of the issued shares.

Purpose of the shareholders’ agreement

The shareholders’ agreement covers the relationship among shareholders, the management and governance of the corporation, and the rights and obligations of the parties involved.

Some areas it addresses:

• Transfer of shares (e.g., restrictions, rights of first refusal)
• Decision-making processes and voting thresholds
• Dividend policies
• Dispute resolution mechanisms
• Exit strategies (e.g., buy-sell provisions, drag-along/tagalong rights)
• Confidentiality and non-compete clauses

“The shareholders’ agreement is a contract where shareholders will agree, between themselves, what they can and cannot do with their shares,” says Pierre Marquis, Senior Legal Counsel - Investment and Specialized Financing at BDC.

He says the agreement typically covers a multitude of scenarios. For example, it can say whether a shareholder who wants to sell shares to a third party must first offer them to the other shareholders. It may also state if the majority shareholders can force the minority shareholders to join in a sale. The agreement often includes rules for what happens if a shareholder leaves the corporation, becomes unable to participate in matters pertaining to the governance of a corporation or passes away.

Why do corporations need a shareholders’ agreement?

Corporations may need a shareholders’ agreement to clarify roles and expectations of those managing the corporation and those in shareholder roles. It also helps define the rights, responsibilities and expectations of shareholders, and helps prevent or resolve disputes and protect both the corporation as well as the investors.

The shareholders’ agreement will also adapt to a growing corporation that sees its structure evolving.

For example, a business might have been born from a university professor’s research and developed into a startup wholly owned by that professor. That startup could then attract individual investors who become important shareholders and will likely request to participate in the management of the corporation as directors. As the corporation grows, an experienced and independent management team may be brought in, with those founding directors transitioning to simple shareholders, and expecting a return on both their initial investment and any additional equity they have contributed.

Marquis says that when a corporation attracts a large institutional investor like BDC, which can invest millions, that investor will require that any existing shareholders’ agreement be amended and that it reflect the value the investment brings to the corporation.

What is a typical shareholders’ agreement?

There are various types of shareholders’ agreements, depending on the size of the business, the numbers of investors and the power dynamics at play.

“The environment in which the entrepreneur operates will dictate what kind of shareholders’ agreement they will enter into,” says Marquis.

He says that even if a corporation is a three-person operation, a shareholders’ agreement may be important.  “The shareholders’ agreement is your first step toward proper governance.”

A shareholders’ agreement will usually cover the following topics:

Introduction and definitions

• Parties to the agreement
• Definitions of key terms (e.g., “shares,” “board,” “deadlock”)

Business objectives and purpose

• Description of the corporation’s business
• Mutual intent of the shareholders

Share capital and ownership

• Initial ownership breakdown
• Rules around issuing new shares

Governance and management

• Board composition
• Decision-making processes
• Matters requiring unanimous or special approval
• Dividends policy

Rights and obligations of shareholders

• Access to information
• Non-compete and confidentiality obligations

Transfer of shares

• Restrictions on share transfers
• Right of first refusal
• Tag-along rights (minority protection)
• Drag-along rights (facilitates full corporation sale)

Exit strategy

• Events triggering share sales (e.g., death, disability, termination)
• Buy-sell provisions
• Valuation mechanisms

Deadlock resolution

• Process for resolving deadlocks
• Options, such as mediation, arbitration and shot-gun clauses

Dispute resolution

• Procedure (e.g., negotiation → mediation → arbitration)
• Governing law and jurisdiction

Miscellaneous

• Term of the agreement
• Amendment procedures
• Notices and communications

Signatures

Execution by all parties, often witnessed

There also exist available template shareholders’ agreements applicable in specific industries. The Canadian Venture Capital & Private Equity Association provides industry-standard model documents on their website for venture capital investments, offering downloadable templates designed as a starting point for drafting shareholders’ agreements. These resources can be customized to suit the specific needs of your corporation.

Important acronyms

SHAG: Shareholders’ agreement

USA: Unanimous shareholders’ agreement

What is a unanimous shareholders’ agreement?

A unanimous shareholders’ agreement (USA) is a form of shareholders’ agreement (SHAG) recognized under Canadian corporate laws. Signed by all the shareholders of a corporation, it gives them the ability to restrict or remove powers from the board of directors and transfer them to shareholders.

A USA gives shareholders greater control over the corporation’s affairs and allows them to make binding decisions on matters such as the appointment of officers, approval of major transactions and strategic direction.

It is important to note that directors have a duty to act in the best interests of the corporation. In contrast, shareholders do not owe fiduciary duties to the corporation and are therefore free to enter into binding agreements that predetermine how they will vote or act in specific situations.

This distinction is fundamental when drafting a USA, particularly in cases where shareholders also serve as directors, as it may affect the enforceability of certain provisions and the proper allocation of decision-making authority.

“The purpose of a USA is to transfer some or all of the powers from the directors to the shareholders,” says Marquis. “If your goal is to give shareholders the ability to veto certain management decisions, then when drafting a shareholder agreement, you’ll need to have all shareholders signing it.”

As for the advantages of a USA, Marquis says “it offers some concessions to the shareholders who might not be as quick to invest in the corporation.” Many, he says, will want to exercise control on certain key corporate matters in return for making a significant investment.

What additional powers do shareholders have?

Marquis and his colleague, Charles Alexandre Brosseau, Senior Legal Counsel, Investment and Specialized Financing, at BDC, outline examples of several additional powers that a shareholders’ agreement can grant to shareholders, particularly institutional investors:

• Electing certain directors
• Approving specific loans
• Confirming key appointments
• Vetoing decisions that could have a financial impact on the corporation
• Appointing a board member
• Requesting an observer at board meetings
• Accessing management information

What is share capital structure?

“Every corporation, by law, has to have at least one category of shares—usually referred to as common shares,” explains Marquis. “These shares must include three fundamental rights: voting rights, the right to receive dividends and rights upon the liquidation of the corporation.”

He says you’ll find detailed descriptions for each class of shares in a corporation’s articles of incorporation. “Each class of share, whether it’s common or preferred, will be described with its specific rights,” says Brosseau.

For instance, if a corporation issues senior preferred shares, those shares will rank ahead of others in the event of liquidation.

Brosseau adds that this would apply to a corporation doing a round of financing. “A new investor can negotiate a liquidity preference attached to the shares subscribed—essentially a ranking of who gets paid first. So, you may have Class A Preferred Shares, Class B Preferred Shares, Class C Preferred Shares and so on. The most recent investor can be first in line, followed by earlier investors and finally the common shareholders.”

Marquis further explains that different categories of shares can be created with varying features. “You can adjust certain rights depending on the class or series of shares concerned,” he says. “For example, you can issue voting shares, non-voting shares or shares that have a preference in dividends or liquidation, but no voting power.”

As corporations expand and engage in capital-raising activities, the legal and structural complexities increase significantly. “This is precisely when the need for tailored share structures becomes critical,” notes Brosseau.

What are Class A shares?

The term “Class A shares” might sound like it has a universal definition, but it’s a flexible label that can mean different things depending on how a corporation uses it.

“It’s a very elusive definition,” says Marquis. “You absolutely need to have what we call common shares—that’s the foundation. Common shares typically carry the three core rights: voting, dividends and participation in liquidation. These are the basic building blocks of any corporation’s share structure.”

From there, corporations can add more layers, such as Class A, Class B or Class C shares. These can be common shares with specific features, or more often, preferred shares with special rights. For instance, you might see Class A Preferred, Class B Preferred and so on.

“Usually, you’ll have one set of common shares, and then you’ll introduce different classes of preferred shares,” explains Marquis. “What distinguishes these classes is often a liquidity preference. That means if the corporation is liquidated, certain preferred shareholders—typically the most recent investors—get paid first.”

Brosseau elaborates: “In your articles of incorporation, you’ll find detailed descriptions for each class of shares. Each class of shares, whether it’s common or preferred, will be described with its specific rights and features. That’s why there’s no universal meaning to the term ‘Class A.’ In one corporation, Class A Preferred Shares could mean preferred shares with voting rights and a 2x liquidity preference. In another, it might mean something entirely different.”

In other words, the label Class A is just a name. What matters is what the articles of incorporation say. “To really know what the term ‘Class A’ means,” says Brosseau, “you have to read the articles describing the share structure for that corporation.”

Next step

Discover the basic concepts of corporate governance by downloading the free BDC guide, The Science and Art of Good Corporate Governance.