“WHEN DO YOU NEED A SHAREHOLDERS’ AGREEMENT?”
A business that has more than one owner needs to consider incorporating a Shareholders’ Agreement in that it provides for an orderly change of ownership under certain circumstances.
What should be in a Shareholders’ Agreement?
- Who will hold what office
- What types of decisions require more than 50% of the shareholders (ie. Firing or hiring staff)
- When dividends will be paid out
- Salary amounts to be paid
- What happens to buyout of a shareholder in the event of death, retirement, bankruptcy or divorce
- What happens to buyout of a shareholder in the event one shareholder wishes to leave the business
- What happens to buyout of a shareholder in the event of disagreements between the shareholders (the use of a shotgun clause or an auction arrangement)
- The value to be paid in each circumstance. The value can be Book Value or Fair Market Value (FMV).
Fair Market Value – Definition
…the highest price available, expressed in terms of money or money’s worth, in an open and unrestricted market between informed, prudent parties acting at arm’s length and under no compulsion to transact.
How to reach an agreement between Shareholders on FMV?
Pre-arranged agreement among Shareholders on the FMV calculation as explained in the Buy-Sell portion of the Shareholder’s Agreement.
Mediation – Go to an independent third party that all Shareholders are in agreement with to make a final and binding decision on.
Appoint a Chartered Business Valuator (CBV) to determine the value of the business.
Methods of Valuation
Wind up valuation method
This method assumes that the shares of the corporation have a value equal to the amount the shareholder would receive, after corporate income tax and personal income tax, if the corporation sold all of its assets, paid its tax, distributed the net cash to the shareholders and then the shareholders paid their tax on the amounts so distributed. This method is usually reserved for a corporation which has no active business such as investment companies.
The “Going Concern” method
The going concern value method calculates a company’s value based on its capacity to produce a stream of cash flow in the future. The greater the cash flow it will produce in the future, the higher the value today.
NOTE: Each industry has different multipliers, this is why a CBV services may be useful to determine the value.
I. Benefit of Funded Buy-Sell Agreement to deceased estate
1. Ensures a market for the shares and guarantee a buyer for the shares of the business
2. Provides heirs with a predetermined price for the shares
II. Benefit of Funded Buy-Sell agreement to the surviving shareholders
1. Protects them from unwanted shareholders
2. Allocates the shares in a manner agreeable to all shareholders
3. Establishes the method to determine the price of the shares
4. Ensures the funds exist to buy out the deceased’s share
For more information, you should seek legal and accounting advice as to what is most appropriate for your company’s business situation. Please fill out the form below if you require further assistance for a Buy-Sell Agreement.