OWNERSHIP OF A CORPORATION is represented by shares of stock. Most of us are familiar with public corporations, for example— Microsoft, Ford, Coca Cola, etc. These corporations have large numbers of owners (i.e., stockholders or shareholders) and are referred to as public corporations because their stock is traded freely and openly through recognized exchanges and markets, such as the New York Stock Exchange and NASDAQ. Conversely, private corporation stock is not traded through recognized exchanges and markets, and private corporations are usually owned by a small number of stockholders (i.e., they are closely held).
Millions of small businesses are organized as corporations, primarily because corporations provide a liability shield. Owners of a corporation are generally not personally liable for the corporation’s debts and obligations. Even though small, private corporations are sometimes viewed as incorporated partnerships, most corporation laws apply equally to both public and private corporations. This can present special challenges for a small, private corporation. Many of these challenges can, and should be, anticipated and addressed in a Shareholder Agreement. The following highlights some critical issues shareholders of private corporations may wish to address.
Corporate stock is freely transferable— and whatever rights a shareholder possesses pass as a single “bundle” when stock is transferred. Obviously, this is a very favorable attribute for public corporation stock. Certainly, the average investor would not want the purchase or sale of Microsoft stock to be limited or restricted in any way. However, this presents a possible problem for a shareholder of a private corporation. Presumably, people join and form small businesses together because, on some level, perhaps subconsciously, they anticipate that they will pursue their business endeavors collectively and as a “unit.” A shareholder may be saddened to learn that her “partner” (perhaps one owning a controlling share of the corporation) just sold his stock and now she has a new “partner.” A Shareholder Agreement may be used to reasonably restrict a shareholder’s right to sell, give, assign or otherwise transfer his/her stock.
Paradoxically, a shareholder may be unable to transfer her stock because there is no active public trading market for private corporation stock. This can present a significant challenge when a shareholder actively involved in the corporation business dies, retires, resigns or otherwise wants to “withdraw” from the corporation. Generally, a shareholder may not “withdraw” from a corporation. That is to say, a corporation is not obligated to repurchase the stock. A Shareholder Agreement may be used to provide or facilitate a market for the stock.
Because public corporation stock is traded freely and openly through recognized exchanges and markets, the price of such stock is constantly updated and published. Stock of a private corporation is not frequently traded and the price is not published. This can present a challenge and result in costly disputes when it comes time to value the stock of a “departing” shareholder. Valuing a private corporation can require significant time, effort, and the assistance of financial professionals. A Shareholder Agreement can establish fair and objective valuation methods.
The foregoing are just a few of the challenges private corporations face. A well-drafted Shareholder Agreement can address these and other challenges, as well as avoid costly litigation. Please contact the author if you wish to discuss this article or his practice areas.
This article is provided solely for the general interest of the reader. The article and its contents are neither intended as, nor should be construed as, legal advice or opinion. Legal advice and opinion are provided by the firm only upon engagement with respect to specific factual situations.
Barry F. Gartenberg, L.L.C.
Attorney at Law
505 Morris Avenue, 1st Floor
Springfield, New Jersey 07081