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Share Control Agreements

A startup may issue the number of shares of each class or series of classes as authorized by the articles of incorporation, and those shares are considered to be outstanding shares until they are reacquired, redeemed, converted, or cancelled, or until the startup reacquires its own shares. If the articles of incorporation or bylaws allow, a startup may also issue rights, options, or warrants for the purchase of shares of the corporation. A startup's issuance of shares is usually accompanied by the concurrent issuance of a share certificate, which contains the name of the issuing corporation, the province under which the corporation is organized, the name of the person to whom the shares are issued, and the number and class of shares, or designation of the share-series that the certificate represents. Share certificates often contain language that limits the shares' transfer to certain parties or that places conditions precedent on any transfers thereafter.

A share transfer restriction, or a restriction on the share's use, may obligate a shareholder first to offer the startup, or other shareholders, an opportunity to acquire the restrictive shares; may obligate the startup or other shareholders to acquire the restrictive shares; may require the startup, or the shareholders of any class of the corporate shares, to approve the transfer of the restrictive shares; or may prohibit the transfer of the restrictive shares to designated persons or class of persons if such a prohibition is not manifestly unreasonable. Generally speaking, a startup's shareholders do not have a pre-emptive right to acquire the startup's un-issued shares, except to the extent that the startup's articles of incorporation might provide, or that might otherwise be provided by common law or statutory rulings. The startup may also designate the preferential or pre-emptive rights of a shareholder whose shares entitles that person to general voting rights, or rights related to the conversion of shares, share subscriptions, or a security that may be converted into a corporate share. One can easily see that, if there were no internal controls on the transfer or sale of shares among the shareholders, it would be difficult to monitor or guide the startup's business decisions made by the Board of Directors (as those affairs are voted upon and confirmed by the shareholders), and difficult, if not impossible, to predict whether a quorum or majority of the shareholders/voters could be persuaded to ratify any particular decision of the Board.

Accordingly, an essential consideration in setting up a closely held startup corporation is the issue of control over the Board of Directors decisions by the founders/shareholders. In most instances, the concern will be with the ability of founders/shareholders to assure election of a director or number of directors commensurate with the understanding of the founders/shareholders. In instances where it is necessary to give a shareholder more voting power than the share ownership would otherwise entitle him or her, there are a number of common devices for that purpose, including irrevocable proxies, voting trusts and shareholder agreements. In many instances, a unanimous shareholder agreement (USA) is adopted to address issues of voting power and other issues. A USA is a distinct from a shareholder agreement in that it must be signed by all of startup shareholders. It is also the only mechanism by which the powers of the directors to manage the business and affairs of the startup can be restricted. All other shareholder agreements are subordinate to the provisions of a startup’s articles of incorporation and do not take priority in the event of a conflict between their respective terms.

Another method of retaining control in the hands of the founders/shareholders is dual class share ownership. Although dual class ownership has been somewhat controversial among investment bankers, the American Stock Exchange recently agreed to allow listed companies to create multiple classes of stock. In addition, the NASD permits Nasdaq listed shares to have dual class shares, and a number of Nasdaq listed companies have dual class common shares. For example, a company might issue 50% of its shares, but attach to such stock only about 10% of the voting power. The outside investors would own the shares with less voting power, and the management and founders would retain the disproportionately higher voting shares. Or one class of shares might be nonvoting. In addition to discouraging raiders, technology companies consider such dual class ownership to present a defence against loss of control of proprietary technology.

Another method of allocating voting control to ensure that minority shareholders have representation on the Board of Directors is to provide for cumulative voting. Cumulative voting allocates to each shareholder a number of votes equal to the number of shares times the number of directors to be elected. This assures that, depending upon the percentage of the voting shares held by such minority, electing at least one director would be assured. Voting trusts may also be used to control the voting of shares, in effect placing the ownership of the shares in a trustee to be voted in accordance with the provisions of the voting trust agreement. In many provinces, the length that a voting trust may remain in existence is limited by statute. The main disadvantage to a voting trust is the difficulty of anticipating issues upon which the trustee may be required to vote and establishing a mechanism for resolving any differences.