Shareholder Agreements 101: What a Washington DC Business Law Attorney Wants Small Business Owners to Know

Two people incorporate a consulting firm in the District, split the stock evenly, and never sign anything beyond the articles and a set of boilerplate bylaws. Three years in, one wants to sell to a competitor and the other refuses. Nothing in their documents says what happens next. A Washington DC business law attorney fields this call regularly, and the honest answer at that stage is that the options are all expensive.

A shareholder agreement is a contract among the owners of a corporation that governs how shares can be transferred, how deadlocks get broken, how an exiting owner gets paid, and who controls day to day decisions. It is separate from the bylaws, and it does work the bylaws cannot.

How is a shareholder agreement different from bylaws?

Bylaws are corporate procedure. They set meeting notice, quorum, officer duties, and election mechanics, and the board can usually amend them. A shareholder agreement is a contract between the owners personally, which means it binds each signer and cannot be rewritten by a board majority.

The provisions small business owners care about most are contractual, not procedural. Bylaws will not tell a departing founder what her shares are worth, and they will not stop a shareholder from transferring stock to an ex-spouse in a divorce settlement. D.C. Official Code § 29-307.32 specifically authorizes shareholder agreements that depart from the ordinary rules of corporate governance, including agreements that restrict board discretion, provided every shareholder signs and the terms are made known to the corporation.

Does D.C. law require a shareholder agreement?

No. A corporation formed under the D.C. Business Corporation Act of 2010 is valid without one, and plenty of District companies operate for years without ever signing one. The statute then supplies the defaults, and the defaults favor stalemate over resolution.

If the owners cannot agree, the remaining remedy is court. Under § 29-312.20, a shareholder can petition the Superior Court for judicial dissolution when the directors are deadlocked and shareholders cannot break it, when those in control act illegally, oppressively, or fraudulently, or when shareholders have been deadlocked in voting power and failed to elect successor directors for two consecutive annual meeting dates. Asking a judge to dissolve a profitable business is a real remedy, but a slow and public one.

What should the buy-sell provisions cover?

The buy-sell section is the part owners actually use, and it needs to answer three questions in writing: what triggers a purchase, how the price is set, and how it gets paid.

Name the triggers specifically: death, disability measured by a standard such as inability to perform duties for 120 consecutive days, voluntary resignation, termination for cause, personal bankruptcy, divorce, and any unapproved attempt to transfer shares. Vague triggers produce arguments about whether the trigger occurred, which is its own kind of litigation.

Payment terms deserve as much attention as price. A closely held company rarely has cash on hand to redeem a quarter of its equity, so agreements commonly allow payment over three to five years under a promissory note at a stated interest rate. Life insurance owned by the company or cross-owned by the shareholders is the standard funding source for the death trigger.

How do you value shares in a closely held D.C. company?

Pick a method now and name it in the agreement. The three approaches that hold up are a fixed price the owners revisit annually and initial, a formula tied to a financial metric such as a multiple of trailing twelve month EBITDA or revenue, and an independent appraisal by a valuation professional selected under a procedure the agreement spells out.

Formulas are cheap and predictable but drift out of line with reality as the business changes. Appraisals are accurate and slow, and they cost money at the moment the parties are least willing to cooperate. Many agreements use a formula as the default and let either side demand an appraisal if the formula result is off by more than a set percentage.

What happens when two owners each hold 50 percent?

Even splits need a tie breaker written in advance, because a 50/50 corporation has no majority to resolve anything. Workable mechanisms include a casting vote for one owner on defined categories of decisions, a neutral third director, mandatory mediation before either owner can force a sale, or a clause under which one owner names a price and the other chooses whether to buy or sell at it.

Do transfer restrictions protect an S corporation election?

They can, and for an S corporation they are close to mandatory. Internal Revenue Code § 1361 caps an S corporation at 100 shareholders and bars ineligible holders such as partnerships, corporations, and most trusts. One transfer to the wrong party terminates the election for everyone.

For a restriction to bind a transferee, D.C. Code § 29-306.27 requires it be noted conspicuously on the share certificate or, for uncertificated shares, included in the information statement sent to shareholders. Build the local tax reality into your distribution terms as well: the District does not recognize federal S corporation status, so the company still owes D.C. franchise tax at 8.25 percent, with a minimum of $250 when D.C. gross receipts are $1 million or less and $1,000 above that.

Sign the agreement while everyone still likes each other, because amending it later takes unanimous consent from the same people who are now in conflict. If you own a corporation in the District without one, or you are holding a template that was never adapted to D.C. law, a Washington DC business law attorney can walk through your ownership structure and put terms in place before a trigger event forces the question. Reach out to schedule a consultation.