Shareholder agreements should be essential to every small corporation’s structure. These agreements outline many aspects of corporate government including ownership and voting rights, control and management, methods of resolving disputes, and two key provisions known as the buy-sell agreement and the restrictive covenant(s).
Buy-Sell Agreements and Restrictive Covenants
Buy-sell provisions and restrictive covenants are both integral parts of a quality shareholders agreement, particularly in smaller businesses with fewer shareholders. Smaller corporations often elect to establish ownership via shares in the business. For example, say a small corporation has four co-owners with each member owning 25 shares out of 100, thus 25% of the business. A shareholder’s agreement between all of the shareholders will serve as the main document that courts will look at if a dispute should arise between the shareholders.
Shareholders’ agreements can be simple or complex and each document is often unique to the corporation it is written for. While many shareholders know about the value of a shareholder agreement, they often are created without the assistance of a Shareholder Rights Attorney, thus lacking key provisions that leave many of the individual shareholders vulnerable. A buy-sell agreement and restrictive covenant provision are two of these key components that should be included in the agreement.
A buy-sell agreement dictates what will happen to the shares of a shareholder who wishes to leave the company. Generally, a shareholder who wishes to leave the company must sell his or her share. Disputes often arise as to what price these shares are being sold for. A departing shareholder will want to sell shares to the highest bidder. This may be someone that the remaining shareholders do not want to be in business with. Also, if the corporation itself or the remaining shareholders are “buying out” the departing shareholder, the departing shareholder often thinks its shares are worth more than the remaining shareholders do. Fortunately, a typical buy-sell provision settles this dispute beforehand, stating who will buy the shares and the price they will be bought at when the departing member leaves the corporation. If any debate arises when a shareholder is leaving, the courts will simply enforce the shareholder’s agreement and the buy-sell provision.
As for a restrictive covenant(s), these provisions are most useful for corporations with significant high-level employees and skilled and highly compensated professionals involving particularized skills, such as finance, science, technology, and sales. A restrictive covenant defines a geographical area where a departing member is forbidden from working, whether it is with a rival corporation or in their own business. As long as the restrictions are reasonable in geography and time, courts will uphold the restrictive covenants. These restrictions are also useful to prevent a shareholder from departing and stealing clients from the remaining shareholders.
Shareholder agreements are complicated and should involve many different topics that a normal shareholder does not think of. Always consult a shareholder agreement attorney before signing any such agreement. Please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com to make sure you’re protected in your enterprise. Please ask us about our video conferencing or telephone consultations if you are unable to come to our office.
By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Shareholder Law Attorney