Effective shareholder or partnership agreements

With each generation, the governance of the family business entity becomes increasingly more complex. Differing perspectives among shareholders, particularly at the sibling or cousin levels, can negatively impact the success of the business, the preservation of hard-earned wealth and the strength of the family unit. While formalizing the governance process with an effective shareholder agreement is essential for the preservation of family relationships and wealth, many businesses struggle to find a solution that meets the needs of all shareholders.

If you have been following our process for avoiding golden handcuffs, you are well on your way to creating an agreement that is not only a sound communication document but one that all stakeholders are willing to sign. You now have greater clarity around your ownership philosophy. You have set the criteria for determining the role of current and future generations and extended family in the ownership and/or management of the company. You have determined the transition principles that will form the foundation of your integrated business transition plan.

You are now ready for the next step: putting all the pieces together to create a shareholder or partnership agreement that is reflective of your shared philosophy and guiding principles. You will want to work with your trusted advisor and your lawyer to ensure all shareholders have clarity on:

1. How the value is calculated in relation to the years of return the business can generate
2. Why the value of the practice is fair to both current and incoming shareholders
3. How a new shareholder will be compensated for the work he or she does - separate from their return on investment
4. How much will be reinvested in the business versus that which will be paid out to shareholders
5. How each shareholder will realize his or her equity when they exit the business

Key Components of an Effective Agreement

The above points constitute what we call the five key components of an effective agreement. It is these five components that will differentiate a principles-based, customized shareholder agreement from a boilerplate version. Be sure your trusted advisor takes you through a process to first develop the non-legal version of your agreement — asking questions that are directly relevant to your philosophy and principles and digging deeply into the “what ifs” of each area.

Component A addresses the process for shareholders to exit, either voluntarily or involuntarily as a result of death, disability or bankruptcy. It also deals with tax management and liquidity issues and how shares are redistributed. With clarity around your philosophy and principles, your lawyer can ensure your agreement prepares for all contingencies such as when a shareholder becomes ill, seriously disabled or bankrupt. In addition, your exit terms should consider how to make the payouts affordable for the business and align with the terms adopted in components B and E.

Component B focuses on the shareholder entrance process, particularly in conjunction with the exit of another shareholder. It documents the rules for purchase including setting the price and the terms of payment. This is usually measured against your specific principles for making the price affordable to both the shareholder and the business. Be sure to link these terms with those of components A and E.

Component C deals with the area of governance and provides guidance around a myriad of issues such as voting and decision-making, dispute resolution, indemnification, responsibilities, privileges, signing authority, confidentiality and guarantees. For example, in this area it will be important to align your views on whether managers who own shares have equal or more authority to non-owner managers.

Component D ensures there are specific processes for compensating those shareholders who contribute to the day-to-day management of the business either as employees or as directors or consultants to the business. For example, in a principles-based agreement you should pre-determine whether or not shareholder employees are compensated on the same grid as third-party managers who perform a similar role.

Component E handles the subject of a shareholder's return on investment — particularly the criteria for measurement and distribution of proceeds. This section should address when and how dividends are paid to shareholders in accordance with your philosophy on financial independence and align with the terms for entering or exiting ownership.

When drafted from your transition principles, your agreement can facilitate a smooth entrance and exit process through an internal stock market methodology and negate the need for a shotgun clause. When an issue or decision point arises, each shareholder will be able to connect the relevant section of the agreement back to the original agreed-upon principles. The result is an extremely powerful communication tool.

It is also important to note that the process for developing such an agreement is as vital as the document itself. It is the process of working together to develop the philosophy and principles that creates the buy-in!

If you would like to learn more about how our approach to developing a principles-based agreement might work for you, simply contact your BDO advisor or a member of The BDO SuccessCare team at 1 800 598 6400.