by Howard Johnson of Campbell Valuation Partners Limited

For any privately-held business where there are two or more shareholders, it is critical to have a shareholders’ agreement that clearly sets out the rights, privileges and obligations of all the shareholders. The major provisions of a shareholders’ agreement are those dealing with decision making, triggering events, valuation and other circumstances that could lead to a transaction among the existing shareholders of the company.

Shareholders have considerable flexibility when determining how various provisions within shareholders’ agreements are established. However, it is important to remember that shareholders’ agreements normally are referred to when the parties thereto have conflicting interests. Therefore, failure to have a shareholders’ agreement that sets out the “rules of the game” in a comprehensive and unambiguous manner can result in a significant investment in time and cost in order to resolve differences in interpretation that inevitably will result.

Decision Making

The shareholders’ agreement should specify the number of Board members and the rights of shareholders to appoint individuals to Board positions. It also should set out how various decisions by the Board are to be made (e.g. simple majority, two-thirds majority, unanimous). It can be dangerous to require unanimous shareholder approval, given that it allows a shareholder with a relatively small ownership interest to thwart the intentions of the majority.

Triggering Events

A triggering event is one that gives rise to the right or the obligation for a shareholder to buy or sell an equity interest in the business. The triggering events that should be addressed in a shareholders’ agreement, sometimes referred to as the “5 D’s” are:

  • the death of an individual shareholder (or dissolution of a corporate shareholder);
  • a long term disability that would prohibit an individual shareholder from being actively involved in the company;
  • departure – either voluntarily or by way of termination;
  • divorce – to prevent inactive spouses from acquiring an equity interest; and
  • debt – referring to the bankruptcy of an individual or corporate shareholder.

For each triggering event, the shareholders’ agreement should set out how the transaction is to be effected (e.g. purchase of shares by the other shareholders or by the company), the method of determining the transaction price, and the terms of payment. In this regard, different triggering events can give rise to different valuation provisions or payment terms. For example, the valuation provisions or payment terms sometimes are less favourable to a shareholder who voluntarily divests of their shares, as contrasted to a sale arising from the death or disability of a shareholder.

Valuation Provisions

Shareholders’ agreements sometimes specify how fair market value (or some other definition of value) is to be determined in the context of a transaction pursuant to a triggering event. The most common methods for establishing value are: (i) agreement by the shareholders; (ii) predetermined formula; (iii) independent expert; (iv) arbitration; or (v) a combination of the latter two where there is disagreement among experts.

Where valuation formulas are used, they often are based on some predetermined multiple of historical accounting earnings (e.g. EBITDA – earnings before interest, taxes, depreciation and amortization) or book value. The use of predetermined formulas can result in unintended consequences, given that the value of a business is influenced by a variety of internal and external factors that are continuously evolving, which may not be reflected in a predetermined formula.

It also is important for the shareholders’ agreement to clearly set out what is meant by “fair market value” or some other value term. For example, the shareholders’ agreement should specify whether (and possibly to what extent) a minority discount should be applied to a non-controlling equity interest in order to reflect the disadvantages associated with a minority equity position.

Buy / Sell Provisions

In addition to the triggering events discussed above, shareholders’ agreements often provide shareholders with the right, or the obligation, to put (sell) their shares to the other shareholder(s), or to call (buy) the interest of the other shareholder(s). Similar to other triggering events, a put or call option may provide that the transaction is to be effected at a pre-established price, a predetermined formula, by independent expert, or arbitration when exercised.

A shareholders’ agreement may also provide for reciprocal buy/sell provisions, often called a shotgun clause. Shotgun clauses most often are encountered in situations involving two equal (50/50) shareholders, and provide that one shareholder can offer to sell their shares to the other shareholder at a price and on terms specified in the offer. The shareholder receiving the offer must either: (i) acquire the shares of the offering shareholder at the price and terms specified in the offer; or (ii) reject the offer and sell their shares to the offering shareholder at the price and terms specified in the offer. Issues may arise in a shotgun clause where the shareholders have materially different negotiating strength. This includes situations where one of the shareholders has access to greater financial resources or where only one of the shareholders is actively involved in the company, and therefore is more knowledgeable about its operations and future prospects.

Right of First Refusal and Right of First Offer

Shareholders’ agreements often include right of first refusal provisions, whereby the shareholder wishing to sell must first solicit third party offers. The shareholder(s) holding the right of first refusal is then presented with the best third party offer received and is given the opportunity to purchase the selling shareholders’ interest based on the price and terms of that offer. If they elect not to purchase the shares within an agreed period of time, the selling shareholder can then sell their interest to the party making the offer on those same terms.

As an alternative to a right of first refusal, some shareholders’ agreements contain a right of first offer, whereby the shareholder wishing to sell their interest establishes a price and terms of sale, which is presented to the shareholder(s) holding the first offer right. If the shareholder having the right of first offer elects not to acquire the shares within an agreed time period, the selling shareholder is free to sell their interest in the open market at a price and on terms that are no less favourable than what was offered to the other shareholder(s).

Dragalong and Tagalong Provisions

Many acquirers of privately-held company shares will close a transaction only if 100% share ownership is delivered. In such circumstances, the controlling shareholder will not want to have a transaction thwarted by one or more minority shareholders. Therefore, shareholders’ agreements frequently provide that if an offer is received for all of the outstanding shares that is acceptable to a specified majority of shareholders, that all shareholders are obliged to tender to the offer on the same terms and conditions. These dragalong provisions protect the liquidity of a controlling shareholder or a group of shareholders that represent control.

At the same time, a shareholders’ agreement should ensure minority shareholders the opportunity to sell into a third party offer at the same price and terms as accepted by the majority. These tagalong provisions (or coattailprovisions) protect the liquidity of all shareholders in the event of such an offer.

Participation in a Subsequent Sale

In some cases where a shareholder disposes of their interest to other shareholders of the company, the acquiring shareholder(s) realizes a windfall profit shortly thereafter pursuant to a subsequent sale of the company to a third party acquirer. To alleviate such perceived unfairness, shareholders’ agreements sometimes provide that during a specified time period after the departing shareholder disposes of their interest, the selling shareholder is entitled to participate pro-rata in any gain on a subsequent sale of the business to a third party. Such provisions can prevent one shareholder within a company from actively consolidating the interests of other shareholders with the intent of delivering the company en bloc to a third party acquirer, and profiting as a result.


The shareholders’ agreement is a key document in any privately-held business having multiple shareholders. While there is considerable flexibility in structuring the terms of the shareholders’ agreement, the provisions dealing with decision making and transactions among shareholders (including triggering events and valuation) should be carefully considered in order to avoid unintended consequences.