Understanding Shareholder Agreements

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One business tool that is often overlooked is the Shareholder Agreement, also referred to as a Buy-Sell Agreement, which should be in place in every partnership. A Shareholder Agreement is a key legal document to protect business owners in the case of an unexpected change to the owners. Typical events include divorce, retirement, death, disability, or bankruptcy of an owner. This document controls future ownership of the business if one of these events occurs. The Shareholder Agreement dictates who buys the shares and at what price. Typically insurance is used to fund the death of an owner. Disability insurance is often included in the event of injury. Often the insurance policy is owned and paid for by the business.

Valuation is the most challenging area in a Shareholder Agreement, as it needs to be fair to all owners and be as close to market value as possible (Holleman). The Shareholder Agreement is sometimes known as a shotgun clause whereby one individual can offer a sale price to the partner at fair market value, or in turn the partner can exercise the shotgun and buy the business at the offered amount. The test in valuation is whether or not every partner would sell their share for the valuation amount. If not, the valuation will need to be revisited.

Sun Life prepared an extensive case study on two partners in Business Continuation—Client Report—Sun Life Sample and illustrated the various aspects of a Shareholder Agreement in Business Succession Planning—A Guide for Business Owners. You can find both of these resources on their website by entering “buy-sell agreement” in the search bar at the top right of the page and by following this link.

Be certain to recognize the importance of such an agreement and consult with legal and insurance advisors when you are defining goals and priorities.

Activity: Understanding Shareholder Agreements

Consider the business you are considering purchasing.

  1. Will you be the sole owner?
  2. Will you need a shareholder agreement?
  3. Explore the materials provided by Sun Life regarding Business Succession. They share valuable information on financial security planning, retirement, taxes, and unforeseen events.
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