Knowledgeable Business Lawyers Advise on Shareholder Agreements and Operating Agreements in Arizona

Phoenix attorneys offer reliable representation for companies and investors

Publicly traded companies issue millions of shares, so the daily trading of company stock rarely has an impact on internal matters such as the mission of the company and the makeup of its board. But closely held companies rely on far fewer investors, so almost any sale of shares could be a tectonic event, shaking the company to its foundations. To limit potential damage, closely held companies create shareholder agreements that set the parameters for an investor’s relationship with the company. At the Law Offices of Donald W. Hudspeth P.C., our Phoenix business attorneys assist companies throughout Arizona with this important aspect of corporate governance. Drawing on decades of experience, we design plans that allow companies to raise capital without destabilizing risks. We also represent investors who want greater assurances before they commit to joining a new enterprise.

Key elements to a successful shareholder or operating agreement

A shareholder or operating agreement is a contract that defines the investor’s role in the company and limits the investor’s right to alienate shares at will. These limitations must be reasonable, or the company will have a very difficult time attracting investors. The key elements to a sound shareholder agreement include:

• Business Model — Company agreements are a function of and flow from the business model. Thus, a working business model is essential, particularly with companies in new industries, e.g. crypto-currency or internet gambling, or with multiple entities or locations. For example, an inventor may have a patent which product could generate millions in company revenues. In such case it is not unusual for the inventor to contemplate owning 50 percent or more of a start-up while the investors own the remaining 50 percent or less. This is not going to fly. If the investors’ contribution were, say, $1 million, an inventor with 50 percent would immediately have $500,000 in his or her company account. And this is before the company has made one sale or earned one dime. Obviously a more realistic business model is needed.
• Statement of rights and responsibilities — A shareholder (including an LLC member) is an owner of the company. Therefore, a shareholder has a fiduciary duty to promote the company’s interests. The shareholder must support the company’s mission, behave professionally and honestly, and refrain from conduct or speech that reflects poorly on the company. The shareholder also has the right to participate in the governance of the company, generally by voting on key issues. The agreement should lay out expectations and note what is required for a shareholder to have a seat on the board.
• Participation requirements — Most small and medium size business owners contemplate that the owners will also work in the business. For example, it is understood that if two veterinarians start a veterinary practice, they will both work, share expenses and divide the profits. But, unless the shareholders’ or operating agreement requires it, active participation is not required. An owner may not work at all and still receive his or her, say 25 percent distribution.
• Rules on transfers of shares — An important purpose of a shareholder agreement is to prevent someone who does not have the trust of the principle owners from getting a controlling interest in the company. Thus, many agreements have rules about selling shares to someone whom the board has not approved. Rules must also set the method for calculating the price of the shares.
• Exit strategy — As with other relationships, owner “break ups” and “business divorce” are common. Thus, it is important to have in place provisions which define how and when one may leave (or be expelled) and what happens next. The agreement should have contingencies in place for when a shareholder passes away or the relationship with an investor simply does not work out. Typically, there will be an agreement for the company to purchase that person’s shares. That agreement should include a mechanism for properly valuing those shares. However, funding such a purchase can strain company resources, so a financing plan should be part of the agreement.
• Dispute resolution — Minority shareholders often feel that the majority are in the driver’s seat and they are just along for the ride. And, they may be. Organizational agreements may have “drag along” provisions which compel the minority owner to follow the dictates of company management in the sale or merger of the company. When the ride feels more like being dragged, the minority can revolt. Disputes alleging shareholder oppression have become increasingly common. To avoid wasteful litigation, your company should have a dispute resolution plan in place. This can include requirements to mediate disputes or go to arbitration before filing a lawsuit.
• Noncompete agreements — A company needs to take steps to prevent a departing shareholder from taking trade secrets and other intellectual property assets and going into direct competition with the company. Although restrictive covenants can be controversial and difficult to enforce if overdrawn, reasonable covenants not to compete in the same line of business for a short period of time, not to target and solicit the company clients or contracts, and or to use or disclose the company’s trade secrets and other confidential information are enforceable in most states.

There are additional considerations depending on the circumstances of the company. Company circumstances also dictate negotiating strength. A speculative startup may not have the leverage to impose restrictions on an investor, whereas a company with a proven track record and solid financials, seeking capital to expand, is usually in a stronger bargaining position. A Phoenix business lawyer at our firm can thoroughly explain all the details of setting up a shareholder agreement.

Contact an experienced Phoenix business lawyer to discuss shareholder agreements

If you represent a closely held company in search of capital, or you are an investor seeking fair terms for your participation, Law Offices of Donald W. Hudspeth P.C. can advise on a shareholder agreement. Our Phoenix business attorneys have ample experience helping clients in your position throughout Arizona. Call us at 866-696-2033 or contact us online today.