Should I Have a Shareholder Agreement?
“Over the decades of serving as a CPA/Virtual CFO for metro Atlanta business owners I have learned much about what does work and what does not. Though you may already have a shareholder agreement you might want to re-visit your contract to ensure it is viable and practical as I have seen many “legal agreements” over the years that were simply not workable for America’s Entrepreneurs. Having a sound, well-thought out shareholder agreement before you add a partner is a critical component of your business’ short/long term business success. It’s a simple fact-all partnerships end. The key is will your business be ready when it does.” — Duluth CPA John Dillard CPA President of His CPA PC
As a Virtual CFO and a CPA to Atlanta/America’s business owners and entrepreneurs, our responsibility is to consider many varied business issues and scenarios before they occur helping you avoid costly miscues along the way. These Top 10 will do much to help you not only consider how partners will/might enter and exit your business but will do much to ensure that management/ownership changes and their impacts are mitigated rather than exaggerated.
Top 10 Attributes of a Good Shareholder Agreement
- Understanding the Tenants of Business co-Management/Ownership. When you add a shareholder ideally you are only doing so as the new owner will add so much value to the business you will make more money, penetrate more markets and gain operational and financial efficiencies. It is prudent, before you consider and document in signed written form offering a partnership, to consider the attributes of what a potential new owner can and will bring to the business.
- Decision Making. Frequently when there are two or more partners who own a business there is another voice to be heard and perspective to be gained. However sometimes in the process, someone has to make the final tough decisions. If you are the majority owner this will most likely always be you, though certainly you may elect to follow the path suggested by a minority shareholder. However in the event you are 50/50 owners this may prove much more challenging as frequently you may differ on the direction but may still have equal voting ability. It is prudent in these cases to determine, in advance, how these issues will be resolved so that you both may work in unison and harmony.
- Valuations. When you are adding a shareholder to an ongoing business, the first issue that needs to be agreed to is the net worth of the business. This allows new and existing shareholders to agree on a purchase value of the business when the new shareholder is purchasing stock. Care should be exercised at this point to consider how this valuation agrees to/reconciles to the valuation that will be in force in a written shareholder agreement when a shareholder elects or is contractually obligated to sell their stock. Typically valuations are based upon either a formula multiplier of earnings or by the performance of an unbiased appraisal from an independent CPA.
- Payment Periods. As you are determining the valuation of a business great care should be exercised in determining the pay period over which a value will be paid, as frequently a multiplier or independent appraisal may result in the calculation in excess of present excess cash/reserves. Typically a percentage of the purchase price is paid at the time of the stock sell with the remaining being paid over a reasonable specified period and stated interest rate.
- Non–Compete Agreements. Great consideration should be given to having all key integral personnel being required to sign a non-compete agreement sufficiently detailed to preclude a key employee/owner “leaving with the store.” The goal of these should not be to hamstring an employee/owner from working in their chosen field, however the agreement should have “sufficient teeth” to protect the company’s business interests for a reasonable time period/geographic distance.
- Intellectual Property. Though frequently intertwined in the minds of many non-compete agreements protection of Intellectual Property is different in that it protects the working knowledge of steps, procedures, methods, patents & copyrights etc. It is a critical component of protecting your business as these assets are at the core of what a business truly is, does and performs.
- With and without cause. All partnerships end. I promise. All of them will at some point cease. The final parting of the ways between you and your partner may be something easy and a time to rejoice or it may be a result of a disability, death or cancelation of employment with cause. All of these situations may result in varied options and determinations for considering valuation payouts and terms. For example a shareholder opting to leave may result in a higher payout than a shareholder being asked to leave for malfeasance etc. Care should be given and consideration noted to ensure that the agreement is fair to all parties and to continue the viability of the business.
- Death & Disability. One of these two or perhaps both will happen to all of us. Guaranteed! Though you may have great respect for the talents and skills of your partner you might not be able to afford them in the event they are disabled and no longer able to work. Absent a shareholder agreement upon a shareholder’s death their assets will pass according to their will/state law. A well drafted shareholder agreement will enable the business to have options to buy the shares of a disabled/deceased shareholder allowing the business to avoid having the stock pass to heirs who know nothing about the business or worse.
- Seek wise counsel. Working closely with your CPA to help make the “tough decisions” and then your attorney to draft a shareholder agreement are essential as using one without the other may result in an agreement that is legal but not practical or vice versa. Surrounding yourself with key advisors will do much to help you ensure your business is “on task rather than tasked.”
- Don’t be in a hurry. If you have an employee you are considering making a shareholder you will want to be sure to “court them” by getting to know them over an extended period of time way before you actually make an employee a shareholder. Being able to see an employee under many varying degrees of success and challenges will do much to enable you to see what you and they are getting into before you decide to become business partners. Also setting up operational, administrative and financial goals an employee has to achieve before even being considered being made a shareholder so they “will have skin in the game” and a history of goal setting and their achievement is a great plus.
The above is a great starting point in understanding many of the most important tenants in establishing a shareholder agreement. However there are many more variables that may be critical to consider and evaluate such as having restricted shares, non-voting stock, provisions covering sale of the business/public offering and the overall compensation plan/employment contract with key personnel. As a CPA in Duluth GA serving Gwinnett & Atlanta entrepreneurs for decades I have learned that a well-crafted and considered shareholder agreement is critical/essential.
This article was written using the words shareholder agreement but would be changed interchangeably with partnership agreement if for a partnership, or membership agreement if for an LLC.