The Purpose of a Shareholder Agreement

In the Commonwealth of Virginia, it's not uncommon for corporations with fewer investors to draft shareholder agreements in addition to their constitutional documents. A shareholder agreement can further define the roles, responsibilities and financial rights of the shareholders of a company. Whereas in large corporations the free trade of stock shares is expected, this exchange of ownership rights may not be practical for company that was structured to be owned by a few individuals.

For example, if a Fairfax, VA law firm were to become incorporated, the half-dozen or so attorneys who own the business may not want a partner selling his or her shares of the practice to an outside investor or investors. With this end in mind, they could include language in the shareholder agreement compelling any member to offer his shares to the other partners before seeking an outside investor. Or for that matter, the shareholder agreement could prevent any shareholder from selling his or her interest to an outsider under any circumstances.

In addition to controlling the shares of the company, a shareholder agreement can also contain language indicating the roles of the part owners of the company. Certain shareholders may have earned their shares in exchange for managing the business, while some investors have agreed to be silent partners in the company. Or a shareholder can also be paid a salary for the performance of managerial work. A shareholder agreement can detail the work that the managing shareholders are expected to perform, and also prevent a silent investor from becoming involved with day-to-day operations.

Consider a restaurateur and another investor who want to form a corporation to open a restaurant in Arlington, VA. The two individuals each own 50% interest in the corporation, but the restaurateur is obliged to spend forty hours per week overseeing operations, while the other investor is required to refrain from interfering with the business in any way.

If properly prepared by a knowledgeable business attorney, a shareholder agreement can:

• prevent shares being sold within the corporation in a way that would create an imbalance of power
• stop shares from being bequeathed or sold to an undesirable outside investor
• prevent shares from being lost in bankruptcy or divorce
• compel shareholders to perform certain roles within the company
• prevent a shareholder from interfering with the business
• establish conditions under which a shareholder would be forced to sell his or her interest in the company (i.e. termination, arrest)
• require that shares be sold at an appropriate value

A properly drafted shareholder agreement can save a business from immeasurable confusion, expense, and damage in the future. Before deciding on incorporating or establishing a business, investors should retain the services of a reputable Virginia business formation law firm.