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Agreements Between Founders

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Agreements Between Founders

Postby Pinskylaw.ca » 01 Aug 2013, 09:17

Partnerships

A very common form of business entity for a start-up company in Ontario is a partnership. A partnership is defined in section 2 of Partnership Act as “the relation that subsist between persons carrying on a business in common with a view to profit.” If it is assumed that two or more persons are carrying on a business with a view to profit, then they must have some agreement or arrangement as to how the partnership will operate. Often this is not a written agreement, although it should be if difficulties are to be resolved at a reasonable cost when a dispute arises.

In order to limit the scope or liability of one partner for the acts of the others, every partnership agreement should define the business for which the partnership is designed. The fees from all business activities could form part of either the firm’s income or of the individual’s income, depending on the definition of the partnership business. Generally, it is better from the partnership’s point of view to include within the definition of the business all related activities. This will minimize conflicts, although it may also extend the areas of potential liability for the other partners.

Corporations

Shareholder agreements are often employed in closely held start-up corporations as a means to fix the relationship of the shareholders and to foresee and prevent disputes over the operation of the start-up. Shareholder agreements are particularly well suited to establishing procedures for the departure of a shareholder and the value that person will be paid for his or her shares. Shareholder agreements address many interrelated issues, but the constant theme found throughout them is the maintenance of stability. Stability is critical to both the start-up corporation and to the shareholders thereof because these start-ups normally rely upon a core group of individuals to insure their survival. The loss of one or more of the shareholders can quite literally terminate the business because they are frequently the company's key, if not only, employees. Not surprisingly, the shareholders will want to retain control over who may obtain or transfer an equity interest in the start-up corporation and how they go about doing it.

In order to preserve this stability, shareholder agreements almost always include a provision that restricts a shareholder's ability to transfer his or her shares. In fact, a typical shareholder agreement prohibits all transfers of the start-up corporation's stock, unless the other shareholders consent. The typical shareholder's agreement also contains a provision that creates an option whereby the start-up corporation is required to purchase a shareholder's shares upon the occurrence of certain trigger events, such as a shareholder's death or disability, the termination of a shareholder's employment with the start-up corporation, or upon the offer of a third party to purchase shares. These provisions are essential to most closely held start-up corporations because they allow the core personnel to regulate who is coming in and going out of the start-up. In other words, they provide stability.

Because there is often no market for the shares, it is difficult to determine the value of a shareholder's investment at any given time. Shareholder agreements deal with the valuation problem in many ways. One common technique is for one or more independent business appraisers to examine the start-up corporation, develop a net value and then divide this value by the number of shares currently outstanding. Then, the parties can either agree to use this value, hire new appraisers to reassess the number, or arbitrate/litigate the issue. An additional measure of protection can be obtained by including a provision whereby if the corporation is sold, then any shareholder who previously sold his or her shares back to the start-up, within a certain period, is entitled to receive the difference between the price he or she previously received and the share price for which the start-up was actually sold. The theory underpinning such a provision is that the actual price paid by a third party for the company is more indicative of its actual value than is an appraisal.
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