Shareholder agreements: the danger of underfunding

(Article written by People Corporation)

Running a business with partners is rewarding, but it also brings shared responsibilities—including the need for robust planning if something unexpected happens. One of the most significant vulnerabilities is having a shareholder agreement (also known as a Unanimous Shareholder Agreement, or “USA”) that is outdated or, crucially, underfunded.

Why Funding Your Shareholder Agreement Matters

A well-drafted shareholder agreement is designed to protect all parties involved in the business. It should clearly define:

• What happens if an owner passes away or becomes disabled
• Who can (or must) buy or sell shares in such events
• How to prevent outside parties—such as a spouse or an estate—from taking control
• Most importantly: ensuring that funds are available to execute the plan

If your agreement lacks sufficient funding, these protections fall apart at the most critical moment.

The Consequences of an Underfunded Agreement

When a shareholder agreement is not properly funded, several problems can arise:

• Forced Sale at a Poor Price: If there’s no funding to cover a buyout, surviving owners may be forced to sell shares quickly—often below market value.
• Financial Scramble: Remaining partners might have to seek a bank loan under duress, which may not be available or can come with unfavourable terms.
• Unwanted Shareholders: The deceased or disabled owner’s family may become shareholders, which can create complications if they have no interest or experience in running the business.
• Legal Disputes: Ambiguities or the inability to execute the buyout can lead to costly legal battles and harm business continuity.

A Common — and Avoidable — Scenario

Consider two owners who build a thriving business and sign an agreement. Time passes, the business grows, and the agreement is forgotten. Then, unexpectedly, one partner passes away. The surviving owner wants to buy the shares, as agreed—but there’s no insurance or funds set aside to do so.

The bank won’t provide a quick loan. The deceased partner’s spouse demands cash. The business is thrown into turmoil at its most vulnerable moment. All of this could have been avoided with proper planning and a small annual investment in funding.

It’s Not Just About Death

Many agreements cover what happens if an owner dies, but far fewer address disability—a much more likely and often more complex situation. If a shareholder becomes disabled:

• Who will buy their shares?
• Who pays them, and how?
• Are they still involved in the business?

Without clear, funded provisions, these questions often go unanswered, leaving the business exposed.

Three Steps You Can Take Today

• Review Your Agreement: When was the last time you looked at it? Is it up to date with your business’s current value and circumstances?
• Clarify the Buyout Plan: Ask what would really happen if a partner leaves, dies, or can no longer work. Is there money set aside? Are insurance policies sufficient?
• Consult a Professional: Don’t try to figure this out alone. A qualified advisor can help you assess your risks, the current value of the business, and your options for funding (insurance, savings, lines of credit, etc.).

Taking Action Is Easier Than You Think

Prevention is far less expensive and stressful than dealing with a crisis. Many organizations (like People Corporation, in partnership with CFIB) offer tools such as the free Business Succession Owner Report, which provides:

• A short intake on your current set-up
• A customized summary of risks and gaps
• A calculator showing what funding may be needed—now and for the future

These resources come with no pressure and no sales pitch, just practical guidance.

Conclusion

An underfunded shareholder agreement can turn a period of grief or crisis into a business emergency, threatening the future of everything you’ve built. With regular reviews, clear planning, and proper funding—often through affordable insurance or other financial arrangements—you can protect your business, your partners, and your families when it matters most.

This article provides general information and is not a substitute for professional legal or tax advice. For advice tailored to your unique situation, always consult a licensed advisor or legal professional.