Key Terms to Include in a Shareholder Agreement: A Practical Guide for Business Owners

When two or more people go into business together through a corporation, a shareholder agreement is one of the most important documents they can put in place. It governs the relationship between shareholders and outlines what happens if things go wrong or right. A well-drafted agreement can help prevent disputes, protect minority interests, and provide clarity on key business decisions. When I review or negotiate a shareholder agreement for a client, I’m focused on ensuring that their rights are protected, their obligations are clear, and that the agreement reflects the practical realities of the business and the relationship between the shareholders. Below I will aim to discuss some of the more important terms that I look for when reviewing a shareholder agreement.

Shareholder Roles and Contributions

One of the key terms to address in a shareholder agreement is the clarity of each shareholder’s role and level of involvement in the business. In some agreements, shareholders are purely financial backers — they don’t participate in operations and leave decision-making to the board of directors and execution to employees. But in many small or growing businesses, shareholders are also expected to contribute directly, whether by bringing in clients, managing operations, handling finances, or overseeing marketing. It’s important to define whether each shareholder is contributing full-time, part-time, or not at all. This prevents future disputes over who was supposed to do what and helps set the tone for how the business will be managed day-to-day.

Financial Contributions and Ongoing Funding Obligations

Another critical issue that should be addressed in a shareholder agreement is the financial contribution of each shareholder. This includes not only the initial capital each party is bringing into the business — whether it’s cash, equipment, or other assets — but also a clear record of what has already been contributed to date. Just as important is deciding whether shareholders will have any ongoing obligation to inject additional funds into the corporation in the future. In many cases, shareholders prefer not to be required to contribute more money down the line, especially if the business runs into financial trouble. If that’s the intention, it needs to be clearly spelled out in the agreement to avoid future disputes or unexpected demands.

Decision-Making Authority and Voting Rights

A well-drafted shareholder agreement should clearly define how decisions are made within the corporation and who has the authority to make them. This includes outlining the voting power of shareholders and directors, and whether the board’s powers are being limited by the shareholders (unanimous shareholder agreement). In many small or closely held corporations, shareholders want most day-to-day decisions to be made by a simple majority of the board or the shareholders. However, certain major or material decisions often require a special resolution, meaning approval by at least two-thirds of the voting parties. These typically include decisions that significantly affect the direction or stability of the business, such as:

Approving expenditures over a certain threshold (e.g., $50,000 or more)
Issuing or transferring shares
Amending the corporation’s articles or bylaws
Entering into loans or significant credit agreements
Selling or purchasing a business
Purchasing or selling significant assets
Dissolving the corporation
Entering into long-term contracts or commitments

By setting out these procedures clearly, shareholders can ensure transparency, accountability, and alignment when major decisions arise.

Restrictions on Share Transfers

In most shareholder agreements, the parties want to ensure that shares cannot be freely transferred to third parties without some level of control. Typically, this means requiring that any proposed transfer of shares first be approved by the board of directors through a formal resolution. This protects the existing shareholders from having an unknown or unwanted third party suddenly become a co-owner in the business. Many shareholder agreements note alternative options for transfer of shares some of which are noted below:

Right of First Refusal

A right of first refusal gives the existing shareholders the first opportunity to purchase the shares of a selling shareholder before they can be sold to an outside party. If a shareholder receives a bona fide offer from a third party, they must present that offer to the remaining shareholders. The other shareholders then have the right to purchase the selling shareholder’s shares in proportion to their existing ownership. If they choose not to exercise this right — and if none of the other transfer mechanisms outlined below are triggered — the selling shareholder is then free to proceed with the third-party sale on the same terms.

Tag-Along (Piggyback) Provision

A tag-along provision — also known as a piggyback right — protects minority shareholders by allowing them to “tag along” in the sale if another shareholder is selling their shares to a third party. If the remaining shareholders choose not to exercise their right of first refusal, they may require that the third-party buyer also purchase their shares, on the same terms and at the same price being offered to the selling shareholder. This ensures that minority shareholders aren’t left behind in a deal that might otherwise result in a shift in control or ownership structure.

Drag-Along Provision

A drag-along provision allows majority shareholders to compel minority shareholders to sell their shares as part of a broader sale of the business. For example, if 70% of the shareholders agree to sell their shares to a third-party purchaser, the remaining shareholders may be required to sell their shares as well on the same terms and conditions. This mechanism is especially important in situations where a buyer is only interested in acquiring 100% ownership and does not want to deal with fragmented or partial control. Drag-along rights help facilitate clean exits and prevent minority shareholders from blocking a full sale of the business.

Shotgun Provision

A shotgun provision is one of the most well-known and often romanticized mechanisms for resolving shareholder deadlock or facilitating an exit. It allows any shareholder to make a unilateral offer to either buy out the other shareholder(s) or sell their own shares at a specified price. The receiving shareholder must then choose to either accept the offer and sell their shares, or buy the offering shareholder’s shares at the same price. This structure is designed to keep offers fair, since the initiating shareholder must be willing to either buy or sell at the stated value.

However, shotgun clauses come with significant risks, especially in situations where one party has greater financial strength. For example, a shareholder experiencing financial hardship may be unable to purchase the other’s shares, even at a low price effectively forcing them to sell at unfavorable terms. While shotguns can be effective tools for resolving disputes, they must be approached with caution and used in the right context.

Anti-Dilution Provisions

Anti-dilution provisions are another critical element that must be carefully considered in any shareholder agreement. These provisions protect existing shareholders from having their ownership interest reduced when new shares are issued. This is typically done by requiring that any new shares first be offered to the existing shareholders in proportion to their current ownership, often referred to as a pre-emptive right. Alternatively, the agreement may allow new shares to be issued freely, even if it results in dilution. The distinction is important: without anti-dilution protection, a shareholder can find themselves significantly diluted if new shares are issued to outsiders which is a common way to sideline or reduce the influence of a particular shareholder. For that reason, these clauses are often a key battleground in negotiations, particularly for minority stakeholders.

Death, Disability, Bankruptcy, and Family Law Claims

Shareholder agreements should always include provisions that deal with unexpected or disruptive life events such as death, disability, bankruptcy, or family law claims. These situations can create uncertainty, especially when shares might end up in the hands of third parties who were never intended to be involved in the business. To prevent this, the agreement often provides that if a shareholder becomes permanently disabled (as defined in the agreement), is declared bankrupt, or if their shares become subject to a family law claim (e.g., division of property in a divorce), then they are required to sell their shares to the remaining shareholders at fair market value. This ensures continuity of control and helps preserve the integrity and operations of the corporation.

Share Valuation Mechanism

When a shareholder is required to sell their shares whether due to death, disability, bankruptcy, or a family law claim, the agreement must clearly set out how those shares will be valued. Most shareholder agreements include a defined valuation method to avoid disputes. This could involve appointing an independent business valuator, using a formula based on EBITDA or book value, or referencing a previously agreed-upon valuation updated annually. Some agreements allow each party to appoint their own valuator, with a third valuator stepping in if there’s disagreement. Setting out a clear and fair valuation mechanism ensures the departing shareholder is compensated appropriately and protects the remaining shareholders from overpaying.

Non-Competition Clauses

Another important provision in a shareholder agreement is the non-competition clause. These clauses are designed to protect the business by preventing departing shareholders from immediately starting a competing venture or poaching clients. While that protection can be valuable, non-compete clauses can also be overly restrictive and harmful, especially in smaller businesses where a shareholder’s skill set is their primary livelihood. For example, a standard clause may prohibit a former shareholder from operating a similar business for one year after their departure, which could effectively prevent them from earning a living in their field. Shareholders should think carefully before agreeing to these terms and ensure the scope, duration, and geographic reach are reasonable and not overly punitive.

Dispute Resolution

Shareholder agreements often include a dispute resolution clause to provide a clear process for handling conflicts. Rather than immediately resorting to costly and time-consuming court proceedings, the agreement typically encourages the parties to first attempt to resolve disagreements amicably. If that fails, the next step is usually mediation, a non-binding process where a neutral third party helps facilitate a resolution. If mediation is unsuccessful, the dispute is then referred to arbitration, where a binding decision can be made by an arbitrator. This structured, step-by-step approach helps maintain relationships, reduce legal costs, and resolve disputes more efficiently.

Conclusion

A well-drafted shareholder agreement is one of the most important documents in any corporation with multiple shareholders. It lays the foundation for how the business will be run, how decisions will be made, and how disputes or exits will be handled. Unfortunately, many people assume they can draft one themselves or download a generic template online only to find out later, during a dispute or major event, that key issues were never properly addressed. These mistakes can lead to serious legal consequences, financial losses, and in some cases, the collapse of the business itself.

At Jahanshahi Law Firm, we regularly help clients navigate the complexities of shareholder agreements. Whether you’re starting a new venture or looking to clean up an existing arrangement, we’re here to ensure your interests are protected and your agreement reflects the realities of your business. If you need help drafting or reviewing a shareholder agreement, do not hesitate to contact us.

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ABOUT THE AUTHOR:

Shahriar Jahanshahi is a corporate lawyer and founder of Jahanshahi Law Firm, advising startups, growth-stage companies, and investors on complex legal, tax, and strategic matters. His practice focuses on corporate structuring, tax planning, private M&A, franchising, and real estate, with a client base that includes high-net-worth individuals, private lenders, and entrepreneurs. For further information about Shahriar Jahanshahi, click here.