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A partnership or shareholders’ agreement describes the promises and obligations of each owner to the others. Since each situation is unique, it's wise to have a lawyer draw up the contract. It may contain many different types of clauses, including:
management and decision making
Who makes the decisions and manages the company or partnership? In a company, it's usually the directors, who are chosen by the shareholders. A shareholders’ agreement usually describes
The agreement may list certain decisions which require special approval of the shareholders (i.e. major expenditures, obtaining loans, selling property etc.).
Unless everyone agrees otherwise, all partners have the right to manage and a simple majority governs decisions. You may prefer to clearly define your roles so that there is less confusion about what your duties are. You may also wish to give one partner the authority to sign contracts on behalf of the partnership, or require all partners to sign. This is especially important in arranging bank accounts or financing.
A "limited partnership" is a special form of
partnership. A limited partner contributes money while the general
partner manages the partnership. The limited partner takes no
management role and is only liable for claims against the
partnership up to the amount that she has already contributed.
A "restrictive covenant" is an agreement not to do something. A non-competition clause ensures that owners do not take part in competing businesses, either while they are current shareholders or partners, or for a specific period of time after they leave the business. The restrictions must be reasonable as to the area and length of time, going no further than necessary to protect the business adequately.
A confidentiality clause prevents any owner from disclosing important, private information about the business which might damage it (i.e. trade secrets, inventories, production methods, etc.).
You may also restrict a partner from engaging in any other work
or "moonlighting." This makes sure that each partner is
giving his full time and attention to the partnership and its
business. Think about this clause carefully: it may or may not suit
you and your partners.
How much start-up capital should each owner contribute to the business? Start-up capital in a company usually involves the "subscription of shares" (money paid to the company for its shares) and/or shareholder loans to the company. Shareholder loans are made in proportion to a shareholder’s percentage ownership in the company.
Unless you agree otherwise, each member of a partnership contributes equally. If by agreement one partner contributes more, she may obtain a greater percentage of the profits.
There are many ways for a company to distribute profits. All companies keep some of their earnings and pay out some to their shareholders. Money can be paid out in the form of salary, interest payments on shareholder loans, or the repurchase of shares.
In a partnership, you should discuss and agree on how to share
any profits. Otherwise, all partners share equally in profits.
In a closely held company, the shares are not actively traded on the stock market. In these types of companies, the shareholders may take an active role in the operation of the company. They may not want to work with new or unfamiliar people.
To deal with this issue, a shareholders’ agreement should restrict the transfer of shares. Two types of clauses are commonly used to do this. One requires the approval of shareholders or directors on all transfers of shares. Another common clause is a right of first refusal. This gives the existing shareholders the right to buy shares before they are sold to anyone else. Sometimes, the right of first refusal belongs to the company itself.
A partner cannot sell his interest in the partnership to third
parties unless there is an agreement which permits otherwise. It
might be unwise to permit partnership transfers. The business
relationship is so close that it might be better to terminate the
existing partnership and set up a new one.
restrictions on admitting new owners
Most shareholders' agreements give existing shareholders the right to have the first chance to buy a percentage of any new shares issued by the company in the future, based on their current percentage ownership in the company. This allows an existing shareholder the right to restrict a third party from buying shares of the company.
A partnership cannot admit new partners without unanimous consent
unless there is an agreement to the contrary.
It's important to set out remedies for failing to obey the contract. Where the default involves the failure to make a payment or loan to a company, a common remedy is to dilute the defaulting shareholder’s percentage ownership in the company.
Another common, though more drastic, remedy is to force a buy-out. This clause permits the other shareholders to force the defaulting shareholder to sell her shares. You should also include a formula for calculating the share price. Since privately held shares are not traded in the open market, agreeing on a price after default can be difficult.
You may decide not to include remedies for defaulting partners. A
partner could simply claim a breach of the agreement, terminate the
partnership, and sue the other partner for breach of contract. It
may be wise to include an arbitration process in the agreement so
that defaults may be resolved by a neutral third party without going
to court. This allows you to settle arguments without destroying the
shotgun or termination-of-partnership clause
Sometimes, the relationship between owners deteriorates to a point where there is no possibility that they can work together any longer.
A "shotgun" clause is the ultimate dispute resolution mechanism when shareholders cannot get along. One shareholder initiates the shotgun by notifying another shareholder and naming a share price. The shareholder receiving the notice must either sell all of his shares at that price or buy all of the other shareholder’s shares at that price.
Once triggered, the shotgun clause will result in a mandatory transfer of the shares of a shareholder. The "shotgun" clause is similar to a game of roulette, since one shareholder or the other will be forced from the company.
Any partner may end a partnership by simply giving notice to the others, unless the parties have agreed otherwise. The assets of the partnership are then divided equally or according to another formula set out in the partnership agreement. One partner may also agree to sell her interest to another.
Or, you could specify in the partnership agreement that
termination can only occur for a number of reasons and then clearly
list those reasons.
sale on death
The agreement should deal with what happens if a shareholder dies. The remaining shareholders may not want the deceased shareholder’s shares to pass to his heirs. You may consider the heirs inexperienced, inept or difficult to work with. On the other hand, a shareholder would want his estate to receive fair compensation for his shares. The solution is to include a formula for determining the value of the deceased shareholder’s shares to be purchased by the other shareholders or by the company.
The death, retirement or bankruptcy of a partner ends the
partnership unless the partners otherwise agree. You may agree, for
example, that the continuing partners may purchase the deceased
partner’s interest from her estate according to a valuation
formula. This may be appropriate where the partnership is successful
and the remaining partners wish to continue the business with a
minimum of interruption.
What happens when an owner becomes disabled? This may cause problems if she works for the business and her absence triggers extra costs. Write this clause carefully so that the interests of both the injured owner and the remaining owners are addressed satisfactorily.
Usually, the injured owner is entitled to all of her normal benefits and payments for 12 months even though she is unable to perform her usual duties. This gives her a chance to recover and return to work.
If the disabled owner is unable to return to her normal duties
after the 12 months, the other owners are entitled to buy her out at
a price determined by an agreed formula. This allows the company or
partnership to move on without bearing further costs.
life insurance issues
Many agreements provide for life insurance on each of the owners. The monies may be used to buy out the deceased owner's share.
The minimum death benefits should cover the estimated value of
each owner's interest in the business. In addition, many owners are
essential to the operation of a business. In some cases, life
insurance can be used to overcome cash flow difficulties until the
vacancy can be filled.
More questions? Phone us at (604) HELP-LAW.
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This page last updated: September 23, 1999
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