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The difference between bylaws and a shareholders’ agreement

| Apr 5, 2023 | Business Formation, Business Formation And Planning, Partnership/Company Agreements And Disputes |

In starting any corporation, you must draft a formal set of rules and regulations that govern the company’s day-to-day operations. Bylaws ensure the corporation adheres to a certain standard and that everyone knows their role in the company. A shareholders’ agreement differs from bylaws because it is an optional arrangement that only regulates the shareholders’ relationship among themselves. Where bylaws provide the legal foundations of how the company operates, a shareholders’ agreement allows the shareholders to know their rights and the extent to which they can exercise their rights given a certain dispute.

How important is a shareholders’ agreement?

In Texas, a shareholders’ agreement allows the shareholders to limit the powers of the board of directors reasonably and can give the shareholders the final decision in certain business affairs. The shareholders’ agreement overrules the corporation’s bylaws. A comprehensive shareholders’ agreement explicitly determines the rights and obligations of majority and minority shareholders and, if done correctly, can eliminate (or reduce the likelihood of) shareholder disputes. It is especially important when any of these circumstances happen:

  • When a shareholder no longer has the capacity to actively own or manage their shares
  • When other shareholders want to buyback the shares of a fellow shareholder who wants to give their shares away
  • When the company wants to buyback the shares of the shareholder rather than sell them to an outside entity
  • When certain shareholders wish to change the board of directors
  • When a shareholder wants to sue a third party or any member(s) of the board on behalf of the company

A shareholders’ agreement should address all the most common possible areas of conflict. It will detail company protocol in matters concerning share transfers, board member appointment as wells as distributional decisions on shares, dividends and stock.

Prevention is key

Make sure your corporation has a solid shareholders’ agreement, so the owners know how to address issues without resentment. It prevents bias and unfair treatment. Because they already know what to expect, all shareholders should follow protocol, and you can stop disputes before they even begin.