Beware whom you make a shareholder

By David H. Shlagbaum | October 6, 2014 | Last updated on October 6, 2014
3 min read

You’re own a thriving business. Your husband has little to do with it. Still, you want to make him a shareholder. Why?

  • If your husband were a shareholder, you could split income with him by paying him dividends, thus reducing your taxes payable.
  • He has industry expertise, so you want to encourage his involvement by giving him a stake in the company and a voice in decision making.
  • You need a capital injection and he’s prepared to put up some money for an equity stake.
  • Or, you might just want to share some of your good fortune.

What could go wrong? Plenty. Here’s what you should know.

First, ask yourself if the marriage is strong. If you have any doubts, giving your husband a stake in the business is unwise.

Then, talk with a lawyer 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 you don’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 you more to buy your 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 goals and comfort zone.

3. Death, divorce and other disasters

Unless the share structure calls for non-voting discretionary dividend shares for your husband, redeemable for nominal consideration, you should enter into a shareholders’ agreement. The agreement should answer questions such as: Does your husband have the right to gift shares of the company under his will, and what happens if you separate or divorce? A shareholders’ agreement can give you the right to buy back shares at an agreed upon price, formula or valuation procedure.

Some other potential disasters—your 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 your husband from holding up a share sale, you can include a drag-along clause in the shareholder agreement. Such a provision compels all other shareholders to sell their stakes in the company to the buyer at a pre-negotiated price.

5. Impact on the estate plan

Your will should prescribe who will inherit your shares. Consider how it will affect your family. 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?

Talking things through is critical to developing the right agreement. Make the process transparent and allow for proper input from your husband and, where applicable, from your children.

David H. Shlagbaum