Benefits of Unanimous Shareholders Agreements

Peter Welsh Law Partnership and Shareholder Agreements

While fledgling startups frequently are short of disposable funds to be expended upon legal documents designed to record the expectations and the participation of the principals, serious consideration should be given to some sort of a Unanimous Shareholders Agreement, almost regardless of how extensive.

Regrettably, not all ventures fully succeed or surpass the wishes of their creators and in the event of a dispute or collapse, the costs, whether through litigation or third party intervention, to resolve disputes, often exceed even the economics at stake.

“Shot Gun” clauses offer a tried and true method for dealing with potential battles of interest.

This is a dual-message. First: all business relationships among parties should have a “divorce mechanism”. The second is that “shot gun” clauses offer an expeditious and expedient method to achieve that divorce without the necessity and costs of litigation.

In essence, “shot gun” clauses allow one party to say: “I want either to buy you or to sell to you: same terms; you choose”.

It’s cutting the pie: the other side chooses which “one-half”.

THE SHOT-GUN NOTICE

But here’s the caution: almost all “shot gun” clauses dictate that the shot gun Notice determines the terms of the shot gun. (NOT the Unanimous Shareholders Agreement in which is found the provision for the shot gun clause).

Extreme care must be taken to set out precisely what are the terms triggered on a shot gun clause. It is not infrequent that the underwriters of the business (the startup entrepreneurs) have guaranteed bank loans or possibly leases of premises or third party contracts. The shot gun Notice should expressly state what is to be done with those third party obligations; most usually, that, whoever is the eventual Vendor of shares, is absolved of all of those third party obligations.

The shot gun Notice is the document in which those terms are set out and they must be set out explicitly because that is what the other party is to receive and must match in order to reverse the shot gun.

A clear example: a business operates for a brief period of time and generates significant Canada Revenue Agency unremitted withholdings or HST obligations together with an operating line of credit and a government guaranteed small business loan. One or the other of the shareholders wishes to get out of the venture but wishes to be absolved of all third party obligations. The shot gun Notice must set out exactly what is to be done with those third party obligations. If they are not expressly set out, there is no obligation of a party to eliminate those third party obligations and the departing shareholder may find himself in the position of being a continuing guarantor of the indebtedness due by his former Corporation and former shareholder/partner.

The message and takeaway is:

1. The shot gun Notice must be triggered with absolute certainty of what is required including full specificity of all terms.

2. Frequently, the party ending up purchasing must renegotiate with third parties all third party obligations in order to secure the release of the vending partner. That takes time and third party cooperation and frequently substituted security to satisfy the third party lender.

Estate Freeze

Peter R Welsh Law Estate FreezeWhat is an Estate Freeze? In short, it is a technique to limit and defer capital gains tax on a shareholder. As we know, upon the sale of shares of a corporation giving rise to a capital gain ( which is the difference between the acquisition cost or the “Adjusted Cost Base” and the selling price), one half of the difference is added to the other income of the seller in the year of sale (there are some income tax provisions which soften the capital gains tax exposure, but for the purposes of this brief introduction, we are ignoring those alternatives).

Upon the death of a shareholder, there is a deemed disposition (or sale) of shares and the capital gains is then calculated and included in the terminal year income tax return of the deceased shareholder. It is advantageous to a shareholder to defer or delay the calculation and payment of that capital gains tax or, better still, to limit its potential growth.

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Partnership and Shareholder Agreements – Going to the Quick

Peter Welsh Law Partnership and Shareholder AgreementsIn nearly 40 years of practice, we have found the absence of partnership agreements or shareholder’s agreements has been the foundation of some unnecessary and usually vitriolic litigation.  Sometimes the litigation results in the demise of the entity, but in every case, the costs are more than significant, far dwarfing the costs of preparing an agreement in the first place.

We have repeatedly found, as well, a simple outline to introduce what is required which can be of significant assistance as business persons start up their relationship. 

We’ve reduced these key points to the following:

  • The 3 G’s

  • The 4 M’s

  • The 5 (or more) D’s

What does this mean?

It is simply this:  the 3 G’s mean “Getting in/Getting along/Getting out.”
The 4 M’s mean: “Money in/More Money in/Money out and Management.”
The 5 D’s mean:  “Death/Disability/Dissolution/Disaster/Desire (to leave)” (and a whole host of other words starting with “D”.)

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