Drafting a Shareholder Agreement? Use This Legal Checklist to Avoid Common Pitfalls
Many businesses begin with a handshake and good intentions, but that's rarely enough when money, decision-making, or disagreements enter the picture.
Key Takeaways
Every corporation with multiple owners needs a tailored shareholder agreement to avoid future disputes and legal risks.
The agreement should clearly define ownership rights, decision-making authority, profit distribution, and exit strategies.
All shareholders should participate in drafting and reviewing the agreement with guidance from a business attorney.
Include critical clauses for dispute resolution, non-compete protections, confidentiality, and share transfer restrictions.
Review and update the agreement regularly, especially after ownership changes, funding rounds, or legal shifts.
A shareholder agreement isn't just a formality—it's a critical legal document that sets the rules of engagement between co-owners. Whether you're launching a startup, growing a family business, or preparing for outside investment, this agreement outlines who owns what, who controls what, and what happens when things change. Without a shareholder agreement, even minor misunderstandings can lead to major legal disputes.
In this post, we'll walk through a comprehensive legal checklist to help you draft or review a shareholder agreement that protects everyone involved. We'll cover ownership structure, profit sharing, dispute resolution, exit strategies, and more while also highlighting common pitfalls to avoid. Whether you're creating your first agreement or updating an old one, this guide will help you build clarity, alignment, and legal protection into the foundation of your business.
What Is a Shareholder Agreement?
A basic definition of shareholder agreement is a legally binding contract between shareholders and a corporation that regulates the relationship between the parties. However, these agreements are so much more. They detail how the corporation will operate and the rights and obligations of shareholders. Assumptions about how a company operates can lead to disagreements and legal challenges.
Shareholder agreements differ from a company's bylaws. Bylaws govern a company's day-to-day operations and provide the legal foundation for running the company. Shareholder agreements govern the relationships between shareholders, including defining their rights and the circumstances under which they can exercise those rights. It is crucial to have these two documents.
Operating agreements and shareholder agreements accomplish the same priorities. However, Limited Liability Companies (LLCs) use operating agreements because the owners are "members" instead of shareholders. Corporations use shareholder agreements.
Every corporation with multiple owners needs a comprehensive shareholder agreement for both the company and the shareholders. Even corporations owned solely by family members or friends need a shareholder agreement to prevent misunderstandings. These agreements are not public documents.
Partners involved in a business may begin a company with the presumption that they agree on procedures, policies, future plans, and rights only to discover they were not in agreement. Putting your agreements in writing ensures that everyone has a thorough understanding of their rights and responsibilities from the outset and reduces the risk of a disgruntled shareholder.
Who Needs to Be Involved in Drafting and Reviewing a Shareholder Agreement?
Because the shareholder agreement is a binding contract that can restrict a shareholder's rights, all shareholders need to be involved in drafting or reviewing the agreement. Using a shareholder agreement found online or obtained from a friend can create more problems than it solves. Therefore, owners are wise to involve a business lawyer, accountant, and other professionals in drafting and reviewing the agreement.
A business lawyer learns about your company and asks questions to draft a customized shareholder agreement that accomplishes your goals. Your attorney helps you consider various factors, including tax implications, regulatory compliance, flexibility to accommodate the company's growth and opportunities, and risk management.
Why a Shareholder Agreement Is Essential
A good shareholder agreement protects the interests of all parties. It clarifies rights, responsibilities, and expectations while preventing misunderstandings and future disputes. A comprehensive shareholder agreement is critical for attracting investors and ensuring business continuity.
Shareholder agreements may address any or all the following subjects and issues:
Define governance and management agreements, including the shareholders' authority to determine specific issues instead of the Board of Directors.
Restrict or identify who may become a shareholder.
Provide for distributions and dividends to shareholders.
Preserve a shareholder's proportionate interest in the company, including in relation to outstanding shares and the holding of other shareholders.
Ensure shareholders or the company has the right to acquire a shareholder's shares in a triggering event, such as divorce, disability, death, or termination of employment with the company.
Place restrictions on the sale or transfer of shares.
Determine the voting rights of shareholders, including whether a simple majority is sufficient or a higher majority is required for some issues.
Provide the methods for resolving disputes and deadlocks.
Develop policies and procedures to protect trade secrets, intellectual property, and confidential information.
Initiate non-solicitation and non-competition provisions to prevent shareholders from taking customers and clients from the company.
Plan for an exit strategy that allows a shareholder's investments to be liquidated under certain circumstances, including plans for succession of ownership and management.
A comprehensive shareholder agreement can prevent costly, time-consuming litigation and legal fees that could harm the company's reputation. Drafting a shareholder agreement is a process. Having the help of an experienced Maryland business lawyer ensures that the process accomplishes your goals.
Shareholder Agreement Legal Checklist
A well-drafted shareholder agreement is essential for preventing disputes and ensuring smooth business operations in any corporation with multiple owners. Your shareholder agreement helps maintain business harmony, investor confidence, and prevent legal disputes.
Key provisions to include:
Ownership structure and share rights
Decision-making authority and voting rights
Profit distribution and dividend policies
Exit strategies and transfer restrictions
Dispute resolution and non-compete clauses
Use the following legal checklist to establish a solid foundation for long-term business success with clarity and legal protection in mind.
A. Basic Ownership and Structure
The shareholder agreement includes a list of all shareholders, their respective percentages of the company, and details of their ownership. You want to ensure all parties involved in owning the company are included.
The agreement should address the different classes of shares, if any, and the rights associated with each class. The agreement may also include pre-emptive rights (the rights of existing shareholders to purchase shares before other investors). This section may also include restrictions on the right to transfer shares, including what happens to stock upon a stockholder's death.
It is crucial to ensure the company is adequately funded. Therefore, the shareholder agreement should specify the nature and amount of initial contributions for individual shareholders, such as cash resources or assets. The agreement should also provide for future funding, including obligations of shareholders to contribute.
B. Roles, Responsibilities, and Decision Making
This section of the shareholder agreement outlines the expected behavior of shareholders. The shareholders have specific roles, rights, and responsibilities. Examples of matters addressed in this section include, but are not limited to:
The right to appoint and remove directors and hire senior management.
Decision-making authority (majority vs. unanimous votes). Some decisions may require a higher percentage than a simple majority.
A list of reserved matters that require shareholder approval, such as acquisitions, mergers, and significant borrowing.
The roles and rights of active vs. passive shareholders.
A deadlock clause to determine how to resolve a deadlock in a vote that is evenly split among shareholders.
Access to company information and reporting obligations, including when and how shareholders may access this information and for what purposes.
Minority shareholder veto power to avoid accusations of minority shareholder oppression.
There may be additional provisions based on the type of company, the owner's preferences, and the company's operations. An attorney may also suggest legally sound provisions and valuable insights that may be helpful or necessary.
C. Profit Distribution
A shareholder agreement must include a dividend policy that defines how and when dividends are paid to shareholders. The agreement should also include rules for how and when profits must be reinvested in the company. Including this information allows shareholders to manage their expectations for returns, aligning them with the company's objectives for future growth.
A closely held corporation may elect to be taxed as an S Corporation, which is a pass-through entity. Each owner pays income taxes on their share of the company's profits. The shareholder agreement may provide for tax distributions. These are payments from the company to its shareholders to help them pay their tax liability incurred due to the company's income being passed through to them. The agreement should specify the tax rate used to calculate the tax distribution, and tax distributions will be paid based on share ownership.
D. Share Transfer Restrictions and Share Sales
There are several restrictions shareholders may want to include in the agreement to control share transfers. Provisions they may choose include:
The right of first refusal or pre-emption rights. It gives the existing shareholders the right to purchase shares before other parties.
Provide majority shareholders with the right to force minority shareholders to participate in a sale of shares the majority negotiates (i.e., drag along rights or bring-along provision).
Provide minority shareholders with the right to participate in the sale of shares by a majority shareholder or group with a majority interest (i.e., co-sale or tag along rights).
The rules for an involuntary transfer of shares because of a shareholder's divorce, death, or bankruptcy.
Share transfer restrictions help ensure fair treatment in case of a sale and keeps everyone on the same page. It helps prevent unwanted external influences while maintaining the company's strength.
E. Exit and Dispute Resolution
The shareholder agreement provides exit strategies to direct what happens if a shareholder leaves. It ensures the continuity of the company and fair treatment for all shareholders. The agreement may address several exit strategies, including outlining buy-sale agreements, dissolution of the company, an Initial Public Offering (IPO), and sales, mergers, or acquisitions. The purpose of an exit strategy is to provide ways for shareholders and founders to sell their stake in the company for profit.
It is essential to include the valuation methods for shares. Failing to include the methods to be used can result in disputes and losses for the company and shareholders.
When disputes arise, it is essential to have clear rules for resolving them. Including this information in the shareholder agreement can avoid litigation.
For example, the agreement may stipulate that alternative dispute resolution (ADR) is required for all disputes or specific situations. ADR can include mandatory arbitration or mediation. The agreement should also include the legal jurisdiction for governing law that apply to the agreement.
A shareholder agreement should also include a deadlock provision. Deadlock-breaking procedures define how a deadlock will be resolved in the event of a tie vote by the shareholders.
F. Non-Compete, Confidentiality, and Intellectual Property
Protecting the company's intellectual property (IP), as well as its clients and customers, is a top priority. Restrictions on competing businesses and solicitation of clients, employees, and customers protect the company's interests and competitive strength.
A well drafted agreement should include confidentiality and intellectual property (IP) protection clauses. It should also include non-compete and non-solicitation clauses. Additionally, an agreement should outline rules and procedures for safeguarding sensitive and confidential information, including those who have access to this information.
G. Amendments and Reviews
Another vital clause to ensure the company's ability to grow is the amendment and review clause. The agreement should define the amendment process, including the procedures for making amendments and the conditions under which they may be implemented. For example, does an amendment require a simple majority for approval or a larger percentage of the shareholders for approval? A straightforward amendment process ensures fairness and stability.
It is wise to review the company's shareholder agreement periodically during regular meetings. The agreement may require review every one to two years. It can also include trigger clauses that mandate immediate review, such as the addition of new shareholders, a shareholder dies, or funding rounds.
Common Mistakes to Avoid
Errors and mistakes when drafting a shareholder agreement can be costly. Mistakes to avoid include:
Using vague or ambiguous language can lead to misinterpretation
Failing to seek legal counsel from an experienced business attorney
Ignoring specific circumstances related to the business
Using a generic template without customization or including "boilerplate" language instead of tailoring the agreement to the unique goals, structure, and shareholders
Failing to clearly define the shareholders' roles, rights, and responsibilities
Allowing third parties to dictate the key elements of the agreement instead of engaging shareholders in drafting and reviewing the agreement
Failing to address state-specific regulations or industry-specific regulations
Leaving out exit terms or transfer restrictions
Using an outdated or unclear method for calculating the value of shares
Not updating the agreement as the business evolves
Failing to update a shareholder agreement
Using overly complex language
Overlooking alternatives to litigation and court proceedings to resolve disputes
Failing to include non-compete and confidentiality clauses
Overlooking dispute resolution mechanisms
Understanding common pitfalls shareholders make when developing a shareholder agreement can ensure your agreement is effective, relevant, and aligned with your company's goals. If you have questions about a shareholder agreement, contact our Maryland business lawyer for help.
When to Update or Redraft Your Shareholder Agreement
As mentioned above, using an outdated shareholder agreement is a common pitfall that shareholders often encounter. A shareholder agreement should include trigger clauses that require the shareholders to review and possibly amend the agreement. It should also require the shareholders to review the agreement annually or every other year to amend outdated provisions.
Events that should trigger a review of the shareholder agreement include, but are not limited to:
New shareholders or investors join the company. You need to update or redraft your agreement to reflect the responsibilities and rights of all shareholders, both new and existing.
Changes in the company's business plan or share sales.
Ownership changes. If there is a significant change in the ownership structure, you must update the agreement to ensure it accurately reflects the current situation.
Changes in how shareholders are paid and/or the payment of shareholder dividends.
The exit of shareholders, succession planning, or a deceased shareholder.
Major business transitions, including mergers, acquisitions, expansion, and incurring significant debt.
Changes in decision making processes, including the process for decision-making or a shareholder's rights to make decisions.
Changes in laws or regulations that impact the business
Unforeseen circumstances may require an immediate review and amendment to the shareholder agreement, such as a shareholder's illness or disability. Keeping a shareholder agreement up to date is a process that requires regular reviews. The agreement should be viewed as an integral part of the company's success rather than being filed away and forgotten.
Final Thoughts
A strong shareholder agreement fosters trust, establishes clear expectations, and prevents chaos within a company. Don't wait until conflict arises—draft or review your agreement now to avoid costly litigation and shareholder disputes. Contact Thienel Law for a shareholder agreement review or to create a new one tailored to your business.
About the Author
Steve Thienel, Esq.
Steve Thienel is a business, estate planning, and tax attorney and the founder of Thienel Law, based in the DMV area. He helps entrepreneurs and business owners with entity formation, contracts, regulatory compliance, and long-term growth strategies. As a seasoned tax controversy attorney, Steve also represents clients in disputes with the IRS and state tax authorities. With over two decades of experience, he delivers clear, practical legal guidance tailored to the real-world challenges business leaders face.