Your client’s a successful woman who owns a thriving business. Her husband has little or nothing to do with it. Still, she wants to make him a shareholder. Why?
● If her husband were a shareholder, she could split income with him by paying him dividends, thus reducing her taxes payable.
● Because of his industry expertise, she wants to encourage his involvement by giving him a stake in the company and a voice in decision making.
● She needs a capital injection and he’s prepared to put up some money for an equity stake
Or, she might just want to share some of her good fortune.
What could go wrong? Plenty. Here’s what you can do to protect your client. (Note, this applies for both husband and wife business owners.)
First, ask if the marriage is strong. If she has any doubts, giving her husband a stake is unwise.
Then, advise her about these five options for structuring the agreement:
1. Voting or Non-Voting
Giving him voting shares means he’s invited to all shareholder meetings. If he owns at least 5% of the company, he can demand directors call a meeting of shareholders on issues of concern to him. If your client doesn’t want that degree of involvement, non-voting shares are a better option.
2. Equity or Non-Equity
Equity shares increase in value along with the company. So, if push comes to shove, it will cost your client more to buy her husband out. Non-equity shares can provide discretionary or fixed dividends, accomplishing the income-splitting goal, and will generally have little or no value if you make them redeemable for their original subscription price. Equity and non-equity shares can be combined with voting or non-voting rights. The mix depends on your client’s goals and comfort zone.
3. Death, Divorce and other Disasters
Unless the share structure calls for non-voting discretionary dividend shares for the client’s husband, redeemable for nominal consideration, she should enter into a shareholders’ agreement. The agreement should answer questions such as: Does the husband have the right to gift shares of the company under his will; and what happens if they separate or divorce? A shareholders’ agreement can give the client the right to buy back shares at an agreed upon price, formula or valuation procedure.
Some other disasters – the husband goes bankrupt, becomes an alcoholic, or suffers a stroke and can’t manage his affairs. A shareholders’ agreement can cover these issues.
Without a shareholders’ agreement, other stakeholders might suddenly appear: on death, a spouse or children from a prior marriage, or estranged children from the current marriage; on a bankruptcy, a trustee or other creditors. Properly structured, the buy-back rights under the shareholder agreement can keep these intruders at bay.
4. Sale of the company
To prevent her husband from holding up a share sale, she can include a drag-along clause in the shareholder agreement. Such a provision compels all other shareholders to sell their shares to the buyer at the price she’s negotiated.
Another avenue would be to provide for an option, exercisable at any time, to buy back her husband’s shares at an agreed-upon price, formula or valuation procedure.
5. Impact on the estate plan
Your client’s Will should prescribe who will own her shares when she dies. Ask her, “If you die and you’ve left your shares to your children, are you content to have created an accidental partnership between your children and your husband? Does your shareholder agreement address that? Have you talked to your children about it?”
Critical to developing the right agreement is talking about it. The process should have transparency and allow for proper input from your client’s husband and, where applicable, from their children.
David H. Shlagbaum is a Toronto Family Business Lawyer and the Senior Partner of Robins Appleby & Taub LLP’s corporate law team.