What is an S Corporation Shareholder Agreement?

An S corporation shareholder agreement is a written document used by S corporations with multiple shareholders. This legal document details what would happen in the event of a shareholder conflict or disagreement. Sometimes this document is referred to as a buy-sell agreement. This can prevent shareholders in small S corporations from selling their shares to others.

Advantages of Having an S Corporation Shareholder Agreement

  • A shareholder agreement offers protection from actions that can terminate a corporation's status as an S corporation.
  • Shareholder agreements create specific protections for minority shareholders.
  • Shareholder agreements create protections for keeping everything fair and balanced between shareholders. They also place limits on shareholders that want to take advantage of the system to give themselves benefits like higher salaries. Specific protections can be put in place to require shareholder approval for changes in compensation so that the payouts stay balanced and are voted on.

Frequently Asked Questions About S Corporation Shareholder Agreements

Can a shareholder agreement prevent you from selling your shares?

In some instances, a shareholder agreement can prevent you from selling your shares. In a typical shareholder agreement, a set of protocols is established for selling shares. When you sell them, they must be offered to the other shareholders before you make a public offering. This gives them the chance to buy the shares and keep the company in the hands of the existing shareholder group that is already invested in it.

If none of the shareholders want the shares, then you can offer them on the public market. However, any sale to a third party must be reviewed and approved by the current shareholder group before any sale is finalized. Essentially, the shareholder agreement gives the current shareholder group the ability to control who your shares are sold to. You can always sell your shares if you can find someone either inside the group or that the group will approve of to buy them.

Why would an S corporation want to have a shareholder agreement in place?

The main goal of a shareholder agreement in an S corp is to maintain the S corporation status. The shareholder agreement gives the shareholders a chance to prevent sales to potential buyers that would be ineligible owners according to the shareholder rules for S corporations established by the IRS. If any of the shares are sold to an ineligible third party, the company is no longer an S corporation since its status is voided immediately.

Is a shareholder agreement only used in an S corporation?

No, shareholder agreements can exist in any business with shareholders. However, companies can use alternative methods that look and sound like shareholder agreements. This is because the lawyers responsible for developing the bylaws and other important information can tailor their company structures so that switching to an S corporation is easier. With the right wording, it is possible to create something similar to a shareholder agreement without it being a shareholder agreement.

How do I set up a shareholder agreement?

While it may be possible for you to write one yourself, it is highly recommended that you get a lawyer to do it for you. Shareholder agreements can be complicated, and a lawyer can make this process much easier.

Steps to Writing an S Corporation Shareholder Agreement

1. Start drafting an S corporation shareholder agreement using a template with boilerplate language.

2. Consider adding clauses as they relate to the business. These can clauses include the following:

  • Indemnity clause where shareholders promise to pay damages they cause, such as if the tax status of the corporation changed because of their actions
  • Compulsory buyout, where one party can buy out the other in case of a disagreement
  • Limiting the ability of shareholders to sell off their shares
  • How new shares are issued
  • Arbitration clause for how legal disputes are handled, usually through mediation

3. Include a list of offices and who holds what office.

  • Think ahead of how the S corporation will be able to change leadership, such as with a vote if someone is unable to do their job

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