Two of the major differences between operating as a corporation versus other types of business entities (such as a sole proprietorship or partnership), are that the corporation is a separate legal entity or “person” under the law, owned by individuals known as shareholders, who own the corporation through corporation shares. As a result, the shareholders and the corporation they own are separate and distinct from each other in terms of ownership of assets, taxes, and legal status.
Corporations can have many shareholders and I find that multiple individuals are forming companies and/or “partnering” together more often than in the past. Forming a company with another individual can be beneficial because it enables one to pool capital with others to start the company, while minimizing risk and exposure. Partnering also allows individuals with different skill sets to come together to achieve a common goal – starting and successfully operating a profitable business.
For most individuals, starting and operating a business is a major decision which will involve a lot of time, energy, effort, financial resources, and sometimes – emotion. The relationship between shareholders in a closely held private corporation is akin to marriage as all parties must rely on each other and work together in order to succeed. Acrimonious relationships between shareholders can be fatal to the operations of a company – if the owners spend all their time focusing on their relationships with each other, will they be able to focus on the business? If the owners distrust each other or feel they are not being treated equally, will they want to work towards a successful venture which they feel will be taken advantage of by others? Acrimonious relationships will not only harm shareholders personally, but it can lead to corporate instability, loss of revenue and even a possible closure or dissolution of the company.
The following are a few ways to avoid shareholder disputes, or if a dispute does arise, how to solve the dispute with the least amount of disruption to the business:
Conduct Proper Due Diligence: If you are looking for investors or partners, or even if you are thinking about starting a company with a friend or relative, due diligence should be conducted before the marriage is consummated. Not only should one focus on the financial and professional skills of their potential partners, one must also focus on the interpersonal aspects and whether or not all of the parties can work together to achieve their goals in a business setting.
Shareholder Agreement:Many individuals like to refer to “partnership agreements” when dealing with others and a business. Although partnerships are a business entity where two parties come together to achieve a common goal, once a corporation is created, the parties are shareholders and any agreement between them as owners of a company would be called a “Shareholder Agreement”.
A Shareholder Agreement is important because it lays out how to manage the affairs of the corporation and will address items such as: how the corporation is to be managed, how decisions are to be made, who shall have certain authority over areas of the business, who will manage the bank account, how many signatures are required for financial transactions, etc. A Shareholder Agreement will also state how profits are to be divided and when a corporation can in fact distribute profits. It is quite possible that shareholders have loaned money to the corporation or provided funds in order to start and operate the corporation. A Shareholder Agreement should state how funds are to be provided, and once funds are provided, how the funds should be paid back – such as before any profits are distributed to any shareholders.
A Shareholder Agreement can govern much more and may include procedures about dispute resolution methods and possible ways of purchasing the shares (also known as a buy-out) of the other shareholders. Every corporation with one or more owners or shareholders should have a Shareholder Agreement, if an agreement does not exist, it can become extremely difficult for parties to determine how to separate in a fair manner if they are no longer able to work together. In a less negative scenario, one party may want to retire or move on to other aspirations and projects. Without a Shareholder Agreement to state the method and procedure of how parties can exit the business, the shareholders of the corporation may enter into a stalemate or conflict if/when they must decide how to move on. With a Shareholder Agreement in place, if one party decides to breach the agreement or not follow the provisions they signed off on, it becomes much easier to commence legal action and implement the provisions of the agreement by demanding specific performance of the provisions agreed upon through legal procedures. To read more on Shareholder Agreements please click here.
Roles & Responsibilities: When multiple parties start a business together, the parties must be on the same page in order to achieve common goals. If the parties are not on the same page, there is a higher chance of conflict. One way to ensure that the parties understand each other right from the infancy stage is to outline the roles and responsibilities of each party. Having these in writing and included in a Shareholder Agreement will force the parties to develop their obligations and commitments to each other. Once this is communicated in writing, it is very difficult for parties to dispute what was promised. At the same time, a contract which states what each party will bring to the business will help remind and focus the parties of what they must do in order to achieve their goals, and what promises they made to their partners.
Although avoiding a shareholder dispute is an ideal situation, given the nature of a closely held corporation, and the inherent reliance upon one another by the parties, disputes often do arise.
Some of the most common disputes between shareholders include:
- Lack of trust
- Disputes over time, effort, equality and fairness
- Compensation and financial disputes
- Majority shareholders making decisions prejudicial or oppressive to minority shareholders
- Disputes of shareholder stake/ownership and value there from
- Fraud and embezzlement of company funds
- Using the company as a personal piggy bank
- Violation of shareholder rights
- Breach of duties and abuse of power
- Breach of contract and agreements between shareholders
- Freezing out shareholders
Ways to solve these common disputes:
Like any relationship, it is always best for disputing parties to sit down together and be open and honest. Through communication, individuals are often able to express their thoughts and feelings and hopefully come to some sort of resolution to move forward.
Unfortunately, sometimes the relationship becomes too strained to the point where it cannot be reconciled. In such cases, it is always best to contact a qualified legal professional who can help provide advice as to how to deal with the dispute. Qualified professionals can help sit down with all parties to mediate and help come to a resolution. If this is not possible, a qualified professional will be able to explain your rights and obligations while providing multiple alternatives to try to solve the dispute. Litigation should be the last resort. Litigation will result in a lot of time, effort, and money being expended, and in most cases, focus as well. While parties are immersing themselves in the heavy demands of litigation, they find it extremely difficult if not impossible to continue to run the business and operate successfully. As a result, careful attention is a must when dealing with disputes. The parties should not act in such a way towards each other that they must resort to litigation. If you are in a shareholder dispute, know your rights, know your options, and make an informed decision to solve the dispute as quickly as possible.