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What voting rights do non-voting shareholders have?

A common question that entrepreneurs/inventors have when incorporating is how to structure the business. The options for structuring a business can be overwhelming, especially when it comes to determining the number of share classes to include in your corporation. Generally, founders will initially want to issue shares to themselves, their investors, and certain employees.

 

This share issuances will typically governed by a shareholders’ agreement and, if necessary, an employee stock option plan (ESOP).

Why employees, you ask?

Offering employees (or contractors) an option to purchase shares from the start of the company incentivizes employees to grow the company as if it’s theirs. It also works as a retention tool – encouraging the employee to stay with the company long-term.

 

What kind of shares should you issue to your employees?

Businesses usually issue non-voting shares to its employees. Issuing shares proves to drive the performance of employees, but founders still want to maintain control over critical decision-making for the business.

Source

 

Are non-voting shares really non-voting?

Although called ‘non-voting shares’, there are certain situations where the legislation under which the corporation was incorporated will give non-voting shareholders the right to vote.

 

For example, Sections 170(1) and (3) of the Ontario Business Corporations Act (OBCA) states that non-voting shareholders may vote on resolutions to amend the corporation’s articles of incorporation if the amendment is related to:

 

  • Changing the maximum number of authorized shares of the non-voting class;

  • Changing the rights, privileges, restrictions or conditions attached to the shares of the non-voting class, or equal to or greater than the non-voting shares class;

  • Changing restrictions related to the issue, transfer or ownership of the shares of the non-voting class;

  • Increasing the maximum number of authorized shares of a class having rights or privileges equal to or greater than the non-voting shares class;

  • Exchanging, re-classifying or cancelling shares in the non-voting class;

  • Creating a new class of shares equal to or greater than the non-voting share class; or

  • Allowing a class of shares to be exchanged for the non-voting class shares.

They will also be able to vote on proposed amalgamations that will affect their share class. In short, non-voting shareholders will have a right to vote on resolutions that will have an impact on the rights attached to their share class (but not necessarily on all resolutions that will have a business impact on them as shareholders). The reasoning behind these exceptions is to prevent the voting shareholders from impairing the rights of the non-voting shareholders, and to prevent the voting majority from oppressing the non-voting shareholders in this way.

 

To view a sample articles of incorporation, click here!

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Overview of Shareholders Agreement

Overview of Shareholders Agreements

 

What is this document?

A Shareholders’ Agreement (sometimes known as a Stockholder Agreement) governs the relationship between the corporation and its shareholders. The agreement can describe how the company is to be managed and the rights and obligations of the shareholders.

 

When would I use this document?

Although it is not legally required for a corporation to have a shareholders’ agreement, shareholders’ agreements are often created when shareholders wish to provide for governance rules that are different from the applicable corporations legislation. For example, shareholders may wish to provide for a specific voting requirements for certain types of decisions.

 

Who signs this document?

The agreement is signed by each of the shareholders and the corporation. An individual with authority to bind the corporation will sign on behalf of the corporation.

 

More details about this document

Shareholders’ Agreements can range in length depending on the complexity of the agreement. A detailed agreement can be dozens of pages in length.

There are two basic types of Shareholders’ Agreements. The Unanimous Shareholders’ Agreement (USA) must be signed by all shareholders and can shift decision-making powers from the directors to the shareholders. The shareholders (rather than the directors) will be legally responsible for such decisions. A simple Shareholders’ Agreement (non-USA) is an agreement among the shareholders that does not shift management responsibilities to the shareholders. Shareholders’ Agreements can be company-sided or investor-sided.

A Shareholders’ Agreement is a method of managing risks and creating mechanisms to resolve problems between the shareholders and the corporation before they arise. This can assist in avoiding legal disputes, as the Shareholders’ Agreement can outline what restrictions exist on the transfer of shares, how voting and approval of decisions is done, what happens in the event of a deadlock, what happens after the death of a shareholder, what confidentiality restrictions apply to shareholders etc.

A Shareholders’ Agreement can also outline how third parties may become future shareholders and can provide safeguards for minority shareholders.

One of the most important uses of a Shareholders’ Agreement for a closely held private corporation is to determine what will happen if one of the principals leaves the corporation.

 

What are the core elements of this document?

The core elements include: Directors, Identification of Shareholders, Valuation of Shares, Director Meetings, Shareholder Meetings, Dispute Resolution, Inactive Shareholders, Share Transfer Provisions, Management of the Corporation, Deed of Adherence, Representations and Warranties.

Some examples of additional clauses include Reporting Requirements, Remuneration of Directors, Anti-Dilution, Drag Along Right, Right of First Refusal, Non-Competition, Non-Solicitation and Confidentiality.

 

Related Documents

Shareholders Resolutions – depending on the circumstances the shareholders may pass a (unanimous) resolution approving the shareholders agreement or an amendment to that agreement

Directors’ Resolutions – since the corporation will be a party to the shareholders’ agreement the directors may pass a resolution adopting the agreement

By-Laws – (also called bylaws) deal with matters such as meetings, voting, borrowing, officers etc.

Minute Book – this is where the corporate records are kept. An up to date copy of the shareholders’ agreement should be kept in the minute book.

Buy Sell Agreement/Shotgun Agreement – an agreement that provides for the forced buyout of a shareholder once it is triggered. These terms could be included in a shareholders agreement or used separately.

Share Buyback Agreement – an agreement that allows the corporation to buy back shares in certain situations eg. death, incapacity, or termination of employment/consulting contract of a shareholder.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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What legal documents are required to connect an inventor with an investor?

Startups depend upon funding, so preparing the right documents can help you obtain the funding you need.

Due Diligence

No matter what stage or type of funding is at hand, the biggest thing that all investors will be concerned with is the quality of the investment. This means assessing any and all risks, whether they are legal, financial, or market-based. A company can make this process smoother by preparing, collecting and organizing the appropriate information. To attract an investor,the company should also properly prepare a few key documents that can assure the investor that the investment is a sound one, and that the company is well-run.

Minute Books

The Minute Book is the official record of the company’s activities. It should include all directors’ and shareholders’ resolutions, corporate bylaws, articles of incorporation and any amendments to the articles, corporate registers including a register of directors and shareholders, share register, subscription agreements, the form of share certificates, the shareholders’ agreement (if there is one) and copies of all major contracts. Investors will want to inspect the Minute Book to ensure that all corporate actions have been properly authorized. It is important to keep the Minute Book up to date and organized.

Term Sheet

A startup should provide a term sheet, otherwise known as a letter of intent. This is a non-binding document meant to lay out the big-picture terms and conditions of the potential investment. This means outlining the structure of the investment, including a timeline for funding as well as the transfer of shares and equity (or other securities) to the investor. Specifications about board structure and responsibilities of the investor can also be included, as well as any substantial points to be included in a future shareholders’ agreement.

Share Subscription Agreement  

If the deal has progressed and the investor is ready to invest in the company, a share subscription agreement will be required. This is the agreement that contains the terms of the deal between the company and the investor—how many shares, at what price, at what time, for what form of payment. Depending on the investor, the company may be required to provide representations and warranties that the startup has no existing undisclosed loans, liabilities, material agreements, or ongoing litigation, and that the agreement will not cause the company to breach any of its other agreements. The subscription agreement also typically contains a statement of the type of exemption being relied upon to exempt the transaction from prospectus requirements under the applicable securities laws.

Shareholders’ Agreement

Now that the investor is a shareholder and interested in how the company is being managed, they may wish to have a shareholders’ agreement in place. The shareholders’ agreement is a flexible instrument that can (among other things) protect the shareholder’s representation on the board, limit the board’s ability to make certain decisions without shareholder approval, or protect the shareholders by giving them preemptive rights when more shares are issued in the future. Many minority investors will want to ensure that the shareholders’ agreement protects their rights and investment.

To see standard versions of the various documents and agreements discussed in this article, visit our Small Business Law Library!

This blog was co-written by Alina Butt.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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What Rights Attach to Your Shares?

Entrepreneurs and investors are rightly concerned about what rights attach to their shares, and what mechanisms are in place to protect those rights. A recent decision of the Ontario Court of Appeal, (Pruner v. Ottawa Hunt and Golf Club, Limited, 2015 ONCA 609 (CanLII)), shines the spotlight on those concerns.

In 1981 JP was admitted as a “fully privileged golfing” member (FPG) of the Ottawa Hunt and Golf Club. He was issued one Class B voting share, and five non-voting Class A shares. Because of a decline in health, he applied 31 years later to become a “senior social” member. He was informed that the Board’s newly adopted policy required him to resign as an FPG member (thus cancelling his ownership of the Class B share) and reapply as a senior social member. JP wished to both continue as a Class B shareholder and change membership categories. He took the matter to court, arguing that “the Board’s newly-adopted policy amounts to a variation or restriction of the rights attached to his Class B share, and that as such, the Board cannot impose such a change unilaterally”. Implicit in this argument is the idea that because in the past JP could have changed membership categories without relinquishing his Class B share, this right attached to him as a shareholder, and no change in Board policy (without a shareholder vote and change of corporate constating documents) could unilaterally strip him of this right.

The letters patent of the corporation (equivalent in function to the articles of incorporation of a business corporation) provided for “5,000 Class B voting shares….with a par value of $10”. The bylaws of the corporation provided that payment of the initiation fee for three categories of membership, which included the FPG but not the senior social member, entitled each such member to one Class B share. The bylaws further provided that when a Class B shareholder ceased to be a member of the club, the club “shall cancel the Class ‘B’ share of that Member”.

The court found that these bylaws made the holding of a Class B share contingent upon the category of membership. The court also found that these bylaws gave the Board the power to implement the policy that required resignation from the club before a former FPG member could apply to become a social member. The policy itself did not affect the voting rights attached to the Class B share.

Because of these bylaws, the right to vote belonged to JP only as the holder of a Class B share, and the right to hold the share attached to his membership category, and not to him personally.

In business corporations, the ownership of a share will not depend on a membership category, but the distinction between the rights attached to the share itself, and the ability of the shareholder to exercise those rights is extremely important.

In business corporations, changes to the articles must first receive shareholder approval. As a result, the minimum features of the shares (voting, dividends, right to participate on liquidation) are contained in the articles. However, the exercise of those rights can be regulated by the bylaws or a unanimous shareholder agreement. For example higher voting majorities can be required for certain types of decisions, or a particular class of shares can have a ‘veto’ right if that class of shares constitutes a certain percentage of the outstanding shares of the corporation.

When purchasing shares, or designing a corporate structure, it is not enough to examine the articles to determine the rights attached to the shares. Careful consideration must also be given to the bylaws and any shareholders’ agreement to determine how those rights may be exercised.

Take away

  • basic rights attached to shares can be found in the articles of incorporation
  • exercise of those rights can be modified by the bylaws or a unanimous shareholders’ agreement

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Legal Tips and Tricks: “Shotgun Clause”

When trying to separate from a co-founder or partner, shareholders carefully review the “shotgun” clause in their shareholder’s agreement.  Shotgun or a compulsory buy/sell provisions are used in the “it’s you or me” situation when one or more of the shareholders decide that they can no longer proceed with the other(s).

TWO SHAREHOLDER SHOTGUN SCENARIO:  Between two shareholders who own shares on a 50-50 split, this is a simple concept.  I’ll write you a cheque (possibly fair market value) for all of your shares or you pay me the same value for my shares.  (Picture one person pointing a shotgun at the other, or the other person wrestling it away and then turning the shotgun at the first person).

IT’S AUTOMATIC:  If drafted properly, the mechanism is intended to be automatic, and will include a time limit to accept/reject.

  The messaging is “if I don’t hear back from you in a month I’ll assume you have accepted, here’s your money, thanks very much, get lost.”

POINT OF NO RETURN:  Once the offer is made, it’s a serious offer and cannot be stopped or revised mid-way, because the targeted shareholders now have the opportunity to “wrestle down” their foes and to turn around the shotguns.  If you’re in the “triggering” faction, your shares are immediately at risk of being bought.   Of course, any side-deal can be worked about between the parties if all shareholders are able to come to terms.

MULTI-SHAREHOLDER SHOTGUN SCENARIO:  With many shareholders, the scene is now of one group of people pointing shotguns at another group.  Things get more complicated if some people want to wrestle away the shotguns and the other people don’t.  This can be handled in two ways:

PRO RATA ALLOCATION:  Acquired shares are usually allocated pro rata as well (or in some other mix if the purchasing shareholders agree) – so that a power imbalance doesn’t inadvertently arise.  If any of the acquiring shareholders waive the right to pay for their shares, then the rest of the acquiring shareholders can take up the slack either pro rata for the shareholders who are willing to pay, or in some other mix agreed to between the acquiring parties, so long as all of the shares are acquired and paid for at the full offered price.

In some cases, the shotgun clause requires a certain minimum percentage of shareholding to proceed – so that a 5% shareholder cannot become a 55% shareholder simply because they have lots of available capital.

MAKE PAYMENT ON TIME:  Invoking a shotgun clause will create a serious amount of tension so the acquiring party had better have the payment ready.  A shotgun clause often includes a penalty so that if payment is not tendered in full, then the non-acquiring parties can acquire the shares of the acquiring parties at a discount.

OFTEN AVOIDED:    The ugly truth about the shotgun clause is that the party with the deeper pockets (rich uncle, more savings) will win in the showdown.   This can be heartbreaking if a shareholder is forced out of a company that they had started because they are short of cash, or do not wish to indebt themselves to cover the cash requirement of the shotgun.   If the targeted shareholders are cash-poor, the acquiring shareholders could get a steal of a deal.   As mentioned above, a way to avoid this is to require that fair market value, as determined by an independent valuation, be the minimum shotgun offer.   Ultimately, the best way to avoid the shotgun is to get along.

 

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Role of the Board of Directors: To Protect the Investors

Many early stage companies are directed by a unanimous shareholder agreement, under which the shareholders take control away from the board and make all decisions by requiring a unanimous vote of the shareholders.  This is sensible when there are a small number of shareholders who have self-financed a business.

Reasonably, as a company starts to grow and take on silent or passive investors who are far removed from the business, decision making will start to occur not by shareholder decision but instead, more formally, at a meeting of the board of directors.

The value of a board is its review of company performance against business plan, standards of governance, and forum for debate.   The board is elected by the shareholders at the annual meeting, or at other times when vacancies occur.  Often a shareholders’ agreement will set rules as to which of the shareholders or groups of shareholders have the right to nominate board members.  For example, a company’s founders may require that one or more board seats are filled by company founders or their nominees (by reserving the right to nominate a replacement director should there ever be a vacancy in those seats).  Major investors will often reserve one or more seats, and “minority” investors may also require a seat.

A company will sometimes also leave room for “independent directors” who are not shareholders or stakeholders.  Recently and famously, eBay has appointed an independent director to its board in response to a claim from investors that the company is poorly governed.  Claims from eBay’s billionaire and activist investor Carl Icahn were leading to a potential proxy battle to spin PayPal out of eBay, for reasons of lack of confidence in the governance of eBay.

 This matter was resolved last week when eBay announced the appointment of David Dorman, formerly of (among other appointments) Motorola Solutions, an “independent member” of the board, with the anticipation that shareholder concerns will be brought forward by such independent member of the board.  As business decisions can be complicated and multi-faceted, debate and discussion is a cornerstone feature of a board of directors, along with diversity of experience and context, amongst the members of a board.

It is clear that, whether a company is growing with a handful of investors, or a public company with thousands of investors, once a company’s investors increase in numbers and are far-removed from the day-to-day operations of the business, they will rely on the voice of the board at regularly scheduled meetings to protect their investment.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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