Shareholder Agreements for Corporations

What Are Shareholder Agreements?

Shareholder Agreements regulate the legal ownership rights of shareholders in a corporation.

There are three documents required to properly form a corporation: (1) the Articles of Incorporation (required to be filed with the California Secretary of State), (2) Bylaws, and (3) a Shareholder Agreement.

Because the Articles of Incorporation are filed with the Secretary of State and are difficult to amend, they are typically brief (often no more than a page or two) and govern only the core governing principles of the corporation along with required information such as the name, address, corporate purpose, agent for service of process, and total number and class of shares authorized to be issued of the corporation.

The Bylaws are kept by the corporate Secretary. Bylaws are relatively easier to amend, and consequently provide much more detail about how the corporation will be managed such as when, where, and how annual meetings will be conducted, the number and election of directors, whether a majority, supermajority, or unanimous vote may be required for particular business decisions, among others. In the absence of such provisions, default statutory and case law rules are applied.

The most important and most negotiated formation document, especially for privately-held corporations, is the Shareholder Agreement. The California Corporate Code restricts what shareholders and directors may provide in the Articles of Incorporation of Bylaws. The concern is that a minority shareholder might nonconsensually become disenfranchised via the Bylaws. In contrast, courts routinely uphold a shareholder’s freedom to contract away its rights via a Shareholder Agreement, freely negotiated into and for which the shareholder receives some benefit for its bargain.

A common provision in Shareholder Agreements relates to the restrictions on the transfer of shares, such as the right of first refusal for other shareholders to purchase at the current fair market value a pro rata share of the stock of a departing shareholder. These transfer restrictions prevent the remaining shareholders from becoming business partners with a stranger, or even a party hostile to the interests of the business. Shareholder Agreements also frequently include non-compete and non-solicitation restrictions, rules on how to distribute profits, rights to employment for one or more shareholders, ownership rights to intellectual property, and other provisions to effect the intents of the shareholders in the management of the corporation.

The Importance of Shareholder Agreements in California

forming a startupWhen forming a corporation in California, shareholder agreements, which regulate the legal ownership rights of shareholders in a corporation and typically provide for restrictions on the transfer of shares and provisions that govern the shareholders’ management of the corporation, are commonly the most negotiated formation document.

Though these are among the most common purposes behind formalizing a shareholder agreement, shareholder agreements are highly versatile and allow companies substantially more utility than provided in the brief description above.

For instance, Zenefits FTW Insurance Services, a San Francisco-based human resources/insurance broker software startup that was once “deemed by some to be the fastest growing software startup in Silicon Valley history,” recently amended their shareholder agreement to increase the combined stake a certain group of investors held in the company, while at the same time cutting the company’s valuation by more than half. In exchange for conceding the additional equity at a significantly lower valuation, Zenefits required in the new shareholder agreement for these particular shareholders to “sign a release of claims against the company,” a recognition that the company was open to potential lawsuits from shareholders after it emerged earlier this year that co-founder Parker Conrad, who has recently resigned, “had written a software program, called ‘Macro,’ that helped employees circumvent state licensing requirements.” The development of this issue with Macro subsequently spurred regulator investigations into Zenefits’ business practices. In addition to efforts made by Zenefits to report problems related to ‘Macro’ to regulators, to repair its licensing systems, and to terminate employees involved with the program, the amended shareholder agreement serves to afford Zenefits additional protection from its shareholders regarding Macro as it moves forward.

Shareholder Agreement Drafting & Reviews By Your Contract Lawyer

When forming a corporation, it is impossible to anticipate the type of problems faced by Zenefits or any circumstances that might affect shareholder relations five or ten years down the line. It is possible, however, to create the best shareholder agreement for your business at this point in time and then amend or replace it with a new shareholder agreement when circumstances change and dictate a new set of terms for the corporation’s shareholders, as was the case with Zenefits.

If you are forming a corporation in California, Your Contract Lawyer can help walk you through important considerations specific to your business’s circumstances that can help shape a detailed and versatile shareholder agreement or amendment to your current shareholder agreement.

To learn more about shareholder agreements and how Your Contract Lawyer might be able to assist you, please contact us via phone or the contact form on this page. If you get a chance, head over to our Yelp page to read reviews of our past work.