Forming a small business with friends? Thinking about starting a new company with your neighbor? Here are some basic tips to avoid shareholder disputes and avoid running into problems with your shareholders or business partners once the business gets going.
Top 5 Things to Consider
- Make sure you enter into a contract
- Define each shareholder’s role in the business
- How will decisions get made and who will be the tie breaker vote?
- What happens if you disagree?
- What happens if someone wants or needs to be bought out from the business?
Enter into a written contract to avoid shareholder disputes.
When two or more people start a business, they typically are friends. As friends, they usually agree on everything for the business and don’t think about shareholder disputes. Also, while the company isn’t making money, they don’t want any unnecessary expenses. Unfortunately, in trying to keep expenses low, the shareholders don’t enter into a written agreement of any kind. In fact, most small businesses are formed on a handshake and a verbal agreement.
In Pennsylvania, if you don’t have an agreement, the Business Corporation Law (BCL) is your agreement. However, the BCL doesn’t define a shareholder’s roles and duties. The BCL also doesn’t help resolve disputes, select a tie breaker, or provide a mechanism to value your specific business.
One of the easiest ways to avoid future arguments is to have a written shareholder agreement. A shareholder agreement makes sure that there is a document that everyone can reference if there is an issue. It is a relatively small upfront cost for peace of mind. For a corporation the agreement is a shareholder agreement and for a limited liability company (LLC) it is a membership agreement.
However, you also don’t want to just sign an agreement without thinking about or consulting a lawyer about the types of things the agreement has to cover.
Read more about the types of agreements Kaminsky Law can prepare, or call / WhatsApp, or text message our lawyers at (215) 876-0800 for a free consultation and quote.
Typical Shareholder Disputes
However, as typical with small businesses, issues that the shareholders didn’t consider when starting a company quickly arise. Some common disputes include:
- One shareholder does way more work than the other shareholder, but the profits are still divided 50/50 resulting in resentment and arguments.
- The shareholders can’t agree on whose responsibility certain jobs or tasks are.
- There is a disagreement about a big expense. One shareholder wants to spend the money and the other doesn’t.
- The shareholders can’t agree how to distribute profits.
- One of the partners is harming the company and needs to be bought out of the business but there is no method for valuing the company.
Important Shareholder Agreement Considerations
Although many of the terms in a shareholder agreement may seem confusing there are key areas of a company’s operation that must be covered.
How is the company divided?
The partners should agree on how much percent of the company each shareholder has. If there are only two shareholders and they are split 50/50, or an even number of shareholders where there can be a deadlock, there should be a tiebreaker vote.
How will decisions be made?
The members should agree on decision making. What kind of decisions can be made in the regular course of business or as part of the day-to-day operation of the company? What kind of decisions require a vote? What kind of decisions require a unanimous vote?
What is each person’s role?
The shareholders should agree on roles and their expected commitment to the business. Who is responsible for what? Is each person coming to work 9-5? Who is in charge of bookkeeping and dealing with the accountant? Who is the tax responsible party?
How will profits be distributed?
Ok great, the company is making money. Now what? Are the profits being reinvested to fuel growth? Should the company buy some assets or make investments into equipment? Should salaries go up? Who is paying taxes? These are all questions that most people don’t think about when starting a business. However, entrepreneurs need to consider these before there is a dispute.
How can I kick a shareholder out?
Most of the shareholder litigation that Kaminsky Law handles arises from this question. A shareholder did something wrong, I want to buy him or her out. What can I do? A good shareholder agreement will consider the types of conduct that should give the company or the other shareholders a right to expel someone.
For instance, if a shareholder steals from the company or misappropriates company assets should the company be able to force the shareholder out? What if a shareholder dies, do you have to have the shareholder’s kids involved in the company? How about if a shareholder gets divorced, are you OK with the shareholder’s former spouse owning half of the person’s shares and getting involved in your business? These are all questions that are best explained by a lawyer, considered, discussed, and agreed on while everyone is still on good terms.
How do we value our company?
Ok, we are buying out one of the shareholders… at what price? How do you value your company–is it a multiple of revenue or a multiple of earnings after expenses are paid? What about if a shareholder does something unlawful, do the other shareholders get to buy the shareholder out at a discount? Should the parties agree on a valuator or a method of valuation?
Schedule a Free Consultation to Discuss your Business Agreement
Hopefully, this blog post gave you some things to think about when planning your new business or partnership. Unfortunately it is next to impossible to cover all of the pitfalls and issues that a small business may have or the disputes the shareholders might face. For that reason (and many others) you should meet with a lawyer and discuss your specific business.
At Kaminsky Law, we have years of experience dealing with all types of businesses, big and small. We have seen and litigated many different types of shareholder disputes. Schedule an appointment to speak to one of our lawyers today. We will gladly hear about your business and help you formulate a business agreement that is right for you!