Because Nothing In Business Lasts Forever: “Exit” Clauses In Shareholder Agreements

Entrepreneurs tend to be optimistic. It takes a certain belief that the world will work out to be willing to take the risk of starting up a business. However, even the most optimistic entrepreneurs should consider avenues to ending their business relationships. In the context of private corporations, there are a range of clauses that can be added to a shareholder agreement that enable shareholders to end their relationship. These clauses, sometimes referred to as “exit clauses” can help corporations limit their risk of lawsuits in the event of disputes and come into effect when one or more shareholders wants to sell their interest in the company.

Different types of exit clauses

There are many different types of exit clauses each with their own pros and cons. When writing a shareholder agreement, consider if the following may be right for you:

Shotgun Clauses

A shotgun clause compels shareholders to engage in a buy out. Shareholders often trigger the clause when director/shareholders can no longer have a working relationship in the corporation. The clause allows one shareholder to simultaneously offer to buy out the other shareholders or sell their own shares at the same price. The other shareholders then have to decide to either sell their shares or buy out the offering shareholder.

This clause is often seen as a particularly harsh way to end a business relationship as it can force individuals to make a major financial decision relatively quickly. Problems can be caused when a shareholder does not want to sell their shares but cannot afford to buy the rest of the shares.

Right Of First Refusal

The right of first refusal is triggered when a third party offers to buy some or all of the shares of the company. When this clause is triggered, the other shareholders have a right to buy the offered shares at the same terms as the third party offered.

This clause can make it difficult to sell a company as third parties may be reluctant to make offers if they know the business is subject to a right of first refusal.

Tag Along Clauses

A tag along clause is triggered when a third party makes an offer to purchase a majority or controlling interest in the corporation. This clause allows other shareholders to require the new buyer to purchase their shares on the same terms. This clause protects minority shareholders from having to remain in business with a new controlling shareholder.

Drag Along Clauses

Like tag along clauses, drag along clauses are triggered when a third party makes an offer to buy the company. The drag along clauses forces minority shareholders to sell their shares on the same terms and for the same price as the majority shareholder. This clause empowers the majority shareholder to decide when to sell the business and prevents minority shareholders from blocking a potential deal.

These clauses reflect only some of the exit clauses that can exist in a shareholder agreement. It is important to consider a variety of clauses that help prevent deadlock, resolve disputes and allow shareholders to sell their interests. When carefully drafted to suit the needs of shareholders, the right exit clause can prevent conflict and expensive lawsuits.

If you are starting a business and want to discuss your options, contact us today at (647)-494-9599 or info@law365.ca to find out how we can help you with your business needs.