Owners of shares of a corporation have the right to vote for directors and to share proportionally in any distribution of corporate profits or, in the case of dissolution, in the distribution of corporate assets. There are several ways to protect these interests of shareholders. Such protection is especially important to shareholders of closely held corporations who may not be able to or do not wish to find a market for their shares.
Preemptive Rights
Preemptive rights are designed to give existing shareholders the opportunity to maintain their shareholder status when viewed relative to all shareholders of the company. Thus, preemptive rights provide that existing shareholders must be given the opportunity to purchase a proportionate amount of any new shares to be issued by the corporation before those shares are offered for sale to others. To the extent that existing shareholders can afford to purchase the stock to be issued, those shareholders may maintain the proportional value of their shareholdings and may avoid so-called "watering down" of their stock.
State statutes under which corporations are chartered vary in how they provide for preemptive rights. Such rights may be required for any corporation chartered under the statute, may be required only if the corporate charter provides for such rights, or may consider such rights to exist if the corporate charter does not expressly negate such rights. Thus, statutes normally provide for preemptive rights as a matter of course or as something that may be authorized by corporate charter.
Agreements Among Existing Shareholders
Existing shareholders may also protect their proportional interests in the corporation by agreeing on provisions for buyouts of other shareholders or by agreeing on restrictions on the transfer of shares.
Buyout agreements are especially important for corporations with few shareholders. Such agreements are a useful planning tool to handle any departure or demise of a shareholder without unnecessary disruption of corporate business.
Whether the buyout agreement should provide for purchase of shares of a departing shareholder by the corporation or by other shareholders may be determined by considering whether such a corporate purchase is permitted by the statute under which the corporation is chartered and by considering the tax consequences of such a purchase. The price to be paid for the shares of the departing shareholder should be determined through a formula decided upon when drafting the corporate charter. Such a formula could set a proportional value of shares that would vary automatically as the value of corporate assets and profits rise or fall.
Shareholders may agree to set restrictions on the right to transfer shares in the corporation. Such agreements are another method to protect proportional rights of shareholders in non-public corporations, and they are particularly useful for closely held corporations in which shareholders wish to control who may participate in the business of the corporation. Restrictions on the right to transfer shares may also serve to maintain the number and type of shareholders needed to retain the right to seek a pass-through of corporate income so that it is taxed only as shareholder income. Another objective of restrictions on share transfers may be to preserve the limited number of shareholders that is necessary to avoid application of requirements of federal or state securities laws.
Copyright 2009 LexisNexis, a division of Reed Elsevier Inc.
