Shareholder Agreements in Ontario: Why Every Business with More Than One Owner Needs One
Starting a business with a partner or co-founder is exciting. The shareholder agreement is usually the last thing anyone wants to think about, it feels legalistic, pessimistic, and premature when everything is going well. It is also one of the most important documents your business will ever have, and the time to put it in place is before you need it, not after.
Here is what Ontario business owners need to know about shareholder agreements.
What Is a Shareholder Agreement?
A shareholder agreement is a contract between the shareholders of a corporation that governs their relationship, how decisions are made, how disputes are resolved, what happens when a shareholder wants to leave, and what happens when a shareholder dies or becomes incapacitated.
It operates alongside the corporation’s articles of incorporation and by-laws but is more detailed, more flexible, and, critically, private. Unlike articles of incorporation, which are filed publicly, a shareholder agreement is a confidential document between the shareholders.
Why the Default Rules Are Not Good Enough
Without a shareholder agreement, the relationship between shareholders is governed by the Ontario Business Corporations Act (OBCA) and the corporation’s articles and by-laws. These default rules were not designed with your specific business in mind. They are generic, they leave many important questions unanswered, and they frequently produce outcomes that none of the shareholders would have chosen if they had thought it through in advance.
For example, under the default rules, a majority shareholder can make most decisions without the minority’s consent. There is no obligation to buy out a shareholder who wants to leave. There is nothing preventing a shareholder from competing with the business after they depart. And there is no mechanism for resolving the deadlock that arises when two 50/50 shareholders cannot agree.
A shareholder agreement addresses all of these gaps.
What a Good Shareholder Agreement Covers
Every business is different, but a well-drafted shareholder agreement for an Ontario corporation will typically address the following.
Decision-making and governance. Which decisions require unanimous consent, which require a supermajority, and which can be made by the board or management alone. This is particularly important in companies with equal or near-equal ownership, where the potential for deadlock is highest.
Transfer restrictions. Shareholders should not be able to sell or transfer their shares to just anyone. Transfer restrictions, rights of first refusal, drag-along rights, tag-along rights, ensure that existing shareholders have control over who joins the company and are protected when a majority shareholder wants to sell.
Buy-sell mechanisms. What happens when a shareholder wants out, or when shareholders cannot agree on the future direction of the business. A shotgun clause, which allows one shareholder to name a price at which they will either buy the other out or sell to them — is a common mechanism for resolving deadlock in equal ownership situations.
Death and incapacity. As discussed in the estate planning context, the death or incapacity of a shareholder without appropriate provisions in the shareholder agreement can be severely disruptive. A well-drafted agreement will address the purchase of a deceased shareholder’s interest, ideally funded by corporate-owned life insurance.
Non-competition and non-solicitation. Preventing a departing shareholder from immediately competing with the business or soliciting its clients and employees. The enforceability of these provisions requires careful drafting, overly broad restrictions are routinely struck down by Ontario courts.
Dividend and distribution policy. How and when profits will be distributed to shareholders — a frequent source of dispute between shareholders who want to take money out of the business and those who want to reinvest it.
The Cost of Not Having One
Shareholder disputes are among the most disruptive and expensive legal situations a business can face. They distract management, damage client relationships, consume cash, and frequently result in outcomes that nobody wanted. The legal fees involved in resolving a shareholder dispute, through negotiation, mediation, arbitration, or litigation, can easily exceed the cost of years of proactive legal advice.
The shareholder agreement is not the pessimistic document it might seem. It is the document that lets the business focus on growing, because everyone knows the rules and the rules are fair.
When to Put One in Place
The right time to put a shareholder agreement in place is when the corporation is formed and the ownership structure is established. The second-best time is now, if you do not already have one.
Existing shareholders can enter into a shareholder agreement at any time, provided everyone agrees. The negotiation of a shareholder agreement can also surface disagreements about the direction of the business that are better surfaced now, while the relationship is intact, than later when the stakes are higher.
If you are starting a business with a partner, or if your business already has multiple shareholders and no shareholder agreement, speak to a business lawyer before the absence of one becomes a problem.
This article is for informational purposes only and does not constitute legal advice. Contact Yombo Grossman Law for advice specific to your situation.
