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Why small businesses need a shareholders’ agreement

Most Californians who are contemplating starting a business are aware that state law requires the filing of articles of incorporation with the Secretary of State and the adoption of written by-laws by the board of directors. These two actions are the minimum requirements to start a corporation or limited liability company (LLC), but they are not the only documents concerning business formation that owners should consider.

One of the most valuable corporate documents is a shareholder control agreement, or, in the case of an LLC, a member control agreement. Both agreements are permitted by California law, but neither is mandatory. Shareholder control agreements have several purposes, among which are the creation of a flexible management structure more like a partnership than a corporation, providing for management of the business without the formality of board meetings and creating a formula and procedure for liquidating the interest of one or more shareholders upon their withdrawal from the business.

Shareholder agreements must be in writing and must be signed by all shareholders at the time of their adoption. If new shareholders are added, they too must sign the agreement (or an amended version if that is the decision of both the current and new shareholders). A shareholder control agreement can be especially valuable if the business has shareholders who are active in the business as well as shareholders who are passive investors. The shareholder control agreement can give day-to-day management of the enterprise to the active members and give control over borrowing decisions and the sale of assets to the passive shareholders (or all of the shareholders).

Shareholder agreements can also address issues that may be unique to the corporation, such as the ownership of patents, place of business, admission of new shareholders and similar issues. Anyone who is contemplating forming a new business will benefit from consulting a lawyer with experience in business formation. Such a consultation can provide advice on the entity form that best suits the needs of the enterprise, tax issues and the governance issues that can be handled in a shareholder agreement.

Source: Findlaw, Corporate Counsel, “Breaking Up is Hard to Do: Why You Need a Shareholders Agreement,” accessed on March 14, 2016