For Business Owners, a Shareholders’ Agreement Is Vital

I love playing board games with my children and the games in our home have been known to get pretty competitive. From time to time, a friend will join, and we always make sure all of the players have a clear understanding of the rules, both those included in the box or any “house rules” we made up to improve gameplay.

Take Monopoly, for example. What happens if you land on Free Parking? Is there a bonus payment for landing on Go? Can a player collect rent while in jail? Failing to settle questions like these before the game begins is a recipe for chaos and bickering.

Yet, when it comes to their most valuable asset, too many business owners opt to leave these types of questions unanswered. Can an owner sell their shares or transfer them as part of estate planning? Can business decisions be made by majority or is unanimity required? Without a shareholders’ agreement, the answers to these questions can be murky at best.

In the absence of a shareholders’ agreement, statutory rules often fill the vacuum of ambiguities. One of the key advantages of a written agreement is allowing owners to contract around the rules otherwise imposed by law. An owner who operates without an agreement better be prepared for the possibility that if his partner dies suddenly, he may find himself in business with her spouse or child instead. A simple provision can give the corporation the right to buy the deceased partner’s shares at a predetermined valuation, keeping them in the hands of the business people. While it’s possible that permitting your partner’s shares to pass to her family is the right decision for your particular business, let that be the conclusion of a considered thought process and not unintended operation of law.

The longer you wait to define the governance of a business, the more likely you will face a surprise situation. Suddenly, previously aligned partners can find themselves on opposing sides of a dispute. Therefore, it is always best to consider the terms of your shareholders’ agreement while still behind the “veil of ignorance”, a maxim in political philosophy that instructs a policymaker to structure a society without any knowledge of their own position in that society (i.e. their ethnicity, wealth, abilities, social status or gender).

The same principle applies to defining the governance rules of your business. Can a shareholder who is convicted of a crime be expelled from the company? Wait until someone is arrested to codify that rule and you can bet each partner’s answer will depend primarily on whether he is the convict or the one left behind to clean the mess. Having these discussions ahead of time allows these decisions to be made impartially and rationally.

There are plenty of excuses a business owner can evoke for delaying the execution of a written shareholders’ agreement. It can entail uncomfortable conversations and exhaust time and resources that are preferably steered towards more pleasant and gratifying pursuits. Moreover, most business owners trust their partners implicitly and assume they will be able to work through any future issues amicably.

They are still living behind the veil of ignorance, naive to the obstacles and opportunities their business will encounter and how the absence of a written agreement can exacerbate problems or turn successes into failures. They don’t yet understand that a shareholders’ agreement that everyone has signed onto, that outlines clear rules and provides a roadmap for navigating thorny situations is an investment in a company’s long-term stability and its owners’ peace of mind.

This article appeared in the June 10 issue of Long Island Business News.