by Maurice Walch
Small businesses account for 98 per cent of all companies in Canada and employed 11.6 million people in 2015. They also create 97 per cent of the new jobs. The death rate of small businesses is also relatively high — 78,430 new companies were started in 2013 but 83,240 small companies shut down, resulting in a net loss of 4,510 employers. Many of these losses were due to unavoidable issues such as general economic contraction or disruptive technology. However, every year business enterprises are lost due to partnership breakdown, death, or having no one to sell the business to. Frequently these issues are entirely avoidable and the businesses could have remained viable entities, capable of increasing net Canadian job gains.
The corporate death rate may be reduced by ensuring that businesses have a written, unanimous shareholder’s agreement that features: a business plan, identifies what each partner will contribute to the enterprise, how decisions will be made, and an exit strategy for shareholders. This ensures all the players are on the same page regarding how the business is to be run, who is responsible for which facet of the business, and how all the parties will work together to achieve their common and individual goals. It is important that this document is developed early in the lifetime of the company. This article will review the unanimous shareholder’s agreement and its primary components. Future articles will discuss two key components — the business plan and exit strategies.
The primary objective of a good shareholder’s agreement is to create an atmosphere of trust within the shareholder group. This is achieved through creating an agreement that fosters effective communication between partners and a common understanding amongst them. By building the plan together, the partners will avoid misunderstandings or mistaken assumptions that can lead to problems within the company. By discussing and agreeing how the company will be financed, and what each shareholder may contribute and commit to the project, the shareholders will build a strong foundation for the company’s future.
Shareholders can change over time. Retirement, death, divorce, or disability of a partner (or spouse) may disrupt the company and the shareholder’s agreement should provide guidance as to how to handle these possibilities. For example, if a shareholder dies and his or her spouse takes their place, the spouse may not have the knowledge or capacity to fulfill the deceased partner’s role. Thus, the other partners may wish to buy the shares back. But what if the surviving spouse doesn’t want to sell them? If the spouse does wish to sell, how are the other shareholders going to pay for the shares? Or if the surviving spouse is a minority shareholder, that person may lose out on income if the surviving shareholders decide not to issue dividends but instead pay higher incomes to themselves and nothing to a non-participating shareholder. How do you protect your spouse from this outcome? It’s a lot easier to agree on methods to deal with these situations when everyone is healthy and on good terms.
Throughout a company’s lifetime there will be successful ventures and others less successful. How will you deal with windfall profits? Will some go into a savings account for when times are tough or does it all get paid out to shareholders? Planning ahead as to how to deal with the ebb and flow of corporate profitability can save a lot of headaches and ensure a company’s survival in the lean times.
Inevitably all shareholders will exit the partnership. Perhaps they want to go in a different direction than the company was originally intended to pursue. Maybe a life-threatening illness forces them to rethink their commitment to the firm. As the partnership changes, it is best to have a shareholder’s agreement that details how to deal with the changes quickly, and in a cost-effective manner.
Your financial planner may be a resource to guide you in the basics of a shareholder’s agreement. Ultimately you should have a lawyer draft the final copy of the agreement as each company is unique. Try to get as much work done as possible with your fellow-shareholders before you take it to a lawyer. Not only will it save you money, but the document will then reflect the unique attributes of your situation.
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