A thoughtful shareholders’ agreement can be one of the most valuable tools a family business has. It can serve several purposes. A few of the easy ones are:
Restrictions on Transfer. A shareholders’ agreement—or similar document—can place appropriate restrictions on transferring shares, particularly transfers outside of the family. It can do so by flatly prohibiting any transfers without some form of permission, or it can give the company and/or the other family members the right to buy the shares first if an owner is looking to sell.
“Drag-Along” Obligations. Even if no one is contemplating a sale of the family business, sometimes unexpected things happen. If the family found itself with no clear succession plan and an unbelievable offer to sell the business, the family would want to be able to proceed without having to win over every single small shareholder. A “drag-along” right would obligate the shareholders to participate in such sale if it was approved or agreed to by some core group.
Governance. As ownership gets diffuse, it gets harder and harder to make decisions by consensus. The business needs to have a way to identify the appropriate leadership and allow them to do their job. A shareholders’ agreement can obligate shareholders to vote for certain individuals to the board of directors to ensure continuity of leadership. It can even provide a proxy or power of attorney so that those closer to the business can independently make the decisions around the company’s leadership and governance.
Liquidity. Just as circumstances might change for the business, circumstances might change for the individual family member shareholders. If shareholders find themselves in a position where they no longer want to own their shares or need an ability to monetize them, a shareholders’ agreement can provide solutions. The company or certain family members could be obligated to buy the shares on certain terms to provide liquidity to the shareholder but also ensure the terms are fair and no one takes advantage of the situation.
There is a multitude of ways that any of these rights or obligations can be tailored to a particular family or a particular business, so this can really be a customized document that makes sense in an individual circumstance. The benefits are clear.
But what if you did not think of putting a shareholders’ agreement in place at the beginning? Or what if you have not done a good job about making sure that every new recipient of shares signs the agreement? What if you now have more than 20 shareholders and no document tying them together? Is there any value in trying now, or has the train left the station?
Certainly, a shareholders’ agreement has the most value when signed by all shareholders. That ensures every single equity owner is playing by the same rules. There are, however, certain rights and obligations that can still add tremendous value, even if only signed by a portion of the family members. For example, depending on the concentration of ownership, an agreement among the core shareholders with respect to governance would still be appropriate. If shareholders representing more than a majority of the outstanding shares signed a shareholders’ agreement in which they commit to vote for board members in a certain fashion, this could still provide some certainty and protection around governance. Similarly, if shareholders representing more than a majority of outstanding shares all agreed to a “drag-along” commitment, the business may be able to complete a potential sale transaction in which it could still sell 100% of the business to a third party without input from each and every shareholder. (For example, a sale structured as a statutory merger under the laws of many states may only need a 51% vote of the shareholders to proceed, effectively requiring even the 49% to sell – so an agreement among 51% might be enough.)
Every family is different and every business is different, but you should keep open the possibility that an agreement among shareholders—even less than all the shareholders—can help add value and bring stability to your family business.
Drew Steen is a business transactions attorney at Davis Wright Tremaine LLP. He represents both buy-side and sell-side clients in mergers and acquisitions, venture capital investments, joint ventures, equity co-investments and restructurings. He also serves as regular corporate counsel for several closely held and family-owned companies. Drew can be reached via email at [email protected] or directly at 206.757.8081.