Crafting a Shareholder's Agreement Protect yourself and your fledgling business with this crucial contract.

Q: A friend and I are starting a business together and intend to incorporate. Somebody suggested that we should have a shareholders' agreement. Can you explain why we need one and what should be in it?

A: The suggestion is definitely a good one, and one that I make to all my clients. Here's why: Like any good written agreement, a shareholders' agreement can clarify what the parties to the agreement originally intended. If disputes arise later about what was agreed to and parties to the agreement remember things differently, a well-written agreement can help resolve issues. Also, putting something in writing forces the shareholders to deal with some "what if" scenarios before any of those scenarios ever become a reality. Although you and your friend are on good terms now and may continue to get along well, sometimes friends who also become business partners find they have unanticipated disagreements. If disagreements arise, it can be very helpful to have a clear idea of what the parties agreed to before they had a falling out or before something changes one partner's ability to continue in the business.

What to Include

What's included in a shareholders' agreement depends on the purpose of the agreement, but a typical one might provide the answers to such questions as:

• who can be a shareholder;
• who can serve on the board of directors;
• what happens if one of the shareholders becomes disabled or dies, files personal bankruptcy, resigns, retires or is fired;
• how much shares of stock are worth;
• whether the corporation will be required to purchase the shares of a shareholder who's leaving;
• and how much will be paid for the purchase of such shares.

What You Need to Know

Remember, all shareholder agreements are voluntary and consensual. They must have reasonable terms and conditions, be interpreted according to general principles of contract law; and cannot be entered into for the purpose of defrauding anybody.

The Buy-Sell Agreement

The most common type of shareholder agreement, a buy-sell agreement, spells out the details of buying and selling shares in a corporation and may create a market for your shares.

Sections of a Typical Agreement

1. Preamble. This short section merely identifies the parties to the agreement. Normally, the corporation and the shareholders are the only parties.

2. Recitals. Here you set forth the reasons for entering into the agreement and the goals to be accomplished by the agreement.

3. Optional vs. Mandatory. Throughout the agreement, you need to determine under what circumstances a buy back of stock shares will be optional or required. If you want the company to be required to purchase back the shares from a leaving shareholder, use "shall." If you want the purchase to be optional, use the word "may."

4. Right of First Refusal. This clause states that if a shareholder decides to sell or transfer his shares to an outside party, he must give the details of the sale to the corporation and allow the corporation and remaining shareholder(s) to match the offer of the outside party and purchase the shares. This clause keeps a departing shareholder from selling his shares to anyone without the remaining shareholder(s) knowledge or consent, thus putting the remaining shareholder(s) "in business" with someone who might not be as skilled as the selling shareholder or have very different goals.

5. Determining a Fair Purchase Price. Usually this is determined in one of two ways: Stating a dollar amount per share that all parties agree to and which can be updated yearly, or agreeing to a formula that will be used to determine a fair price at the time of the triggering event. You may need to work with an accountant to help you establish a reasonable formula.

6. Insurance Policies That Provide Buy Out Money. Unless the corporation has purchased and paid into an insurance policy to provide funds to be used in buying out a selling shareholder, the remaining shareholder(s) may find themselves writing a personal check to cover the sale. Be sure to get advice from a knowledgeable insurance professional and an accountant before choosing an insurance policy, but certainly think about having one.

What to Do Next

Begin gathering samples of shareholder agreements from other business owners or from your local Small Business Development Center. When you and your partner have agreed on what you want to accomplish in the agreement, see a SBDC consultant at no charge for help on drafting your agreement. You'll want to have an attorney and an accountant advise you on the final version.

Carlotta Roberts has a J.D. degree from Atlanta Law School. Having worked in the areas of business organization, contracts and employer/employee relations, she's been a consultant to small-business owners since 1981. She worked as a staff attorney concentrating in employment law issues before joining the Small Business Development Center national network in 1986. Currently area director for the Kennesaw State University Small Business Development Center near Atlanta, she has developed two nationally recognized programs: The Cobb Micro Enterprise Council, which won the Vision 2000 award for small-business development in 1999, and the Franchise Institute, developed to provide assistance to franchisees.

The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.