I am amazed at how many companies let their shareholders’ agreements get stale. This agreement is one of the most important corporate documents in a private business because it represents the terms of trade in the company’s stock between the shareholders. All too often, companies and their advisors view it as a necessary corporate document that is set up by legal counsel in a boilerplate fashion and then it gets put in a drawer along with other company paperwork. This is a big mistake.
The shareholders’ agreement should be a living document that the shareholders take an active role in designing (with the help of advisors) and monitoring on a regular basis. Here is why:
- The shareholders’ agreement is the key document that spells out the buy and sell provisions related to the stock and how it is valued. This is especially critical because unlike public company stock, which is valued daily and traded on an open market, private company stock is not freely tradeable.
- Private company owners typically have a significant amount of their personal wealth tied up in their company’s stock. Given that reality, owners should have a clear understanding of the agreement’s provisions and ensure they are updated in line with the company’s changing conditions.
One aspect of these agreements you should pay particular attention to is how the value of the shares is determined. Many boilerplate agreements require an independent, third-party valuation report for every transaction event among the shareholders. We don’t agree with this approach.
We believe it is more reasonable for shareholders to agree on a valuation formula (with the help of a valuation advisor), and to calculate and review the value after year-end. Doing so allows the shareholders to monitor the stock’s value for purposes of activities such as setting insurance coverage, and it also helps them to plan for their own futures. Reviewing the value and the terms of the agreement on an annual basis is typically frequent enough for most shareholders to address changes that are needed.
If you have not reviewed your shareholders’ agreement recently, add it to your to-do list for 2023. If you would like to discuss your shareholders’ agreement or would like a professional to review it, please contact us.