On the establishment of a private company in Australia, it is common for shareholders to enter into an agreement with each other (a ‘shareholders agreement’), governing key aspects of the business. Here we explain why shareholders agreements are useful and set out some of the key terms that you should include in them.
Table of contents:
Why is it important to have a shareholders agreement?
The company legal form that was first settled on 100 years ago was designed with larger firms in mind, whose shareholders tend to be more ‘hands off’. As companies have become a crucial business model for owner-operators in Australia, shareholders have become actively involved in the business. This makes the need for a shareholders agreement more pressing.
A shareholder agreement puts in detail, and in writing, the arrangements between owners about their role in the business. For most businesses in Australia, this will apply to a ‘proprietary limited company’ — a business with 50 or fewer non-employee shareholders which is not publicly listed. These companies need to have a range of official documents in place, including a constitution and shares register. A shareholders agreement, while not compulsory, is highly recommended.
The benefits of having a shareholders agreement in place include:
- Minimising and managing disputes. With clear agreement on the rules that govern the company, there is less likely to be protracted disputes. At the same time, a dispute resolution mechanism written into an agreement makes it easier to resolve a dispute if it does come up. For an example of how shareholder disputes can arise and be managed check out our shareholder dispute case study.
- Protecting the interests of minority shareholders. Without an agreement in place, decisions will general be governed by ordinary resolution (simple majority rules) or special resolution (75 percent to pass). This means that majority shareholders can take actions that are not in the interests of minority shareholders (though note the Corporations Act 2001 (Cth) prohibition on ‘minority oppression’ (section 2323)). A shareholder agreement could provide, for example, that all shareholders need to agree to the issuing of new shares to give minority shareholders a voice.
- If there is no shareholder agreement in place, there are no explicit mechanisms for shareholder exit. This means, for example, it will likely be impossible to apply a non-compete clause to an exiting shareholder.
- Reining in directors/managers. Under the Corporations Act 2001 (Cth), there are some powers that are always reserved for the shareholders of the company (such as the power to wind up the company). But the shareholders may also wish to use the shareholders agreement to reserve further decisions for themselves and remove some of the power from directors — this is especially true where directors will be non-shareholders/members.
What terms should a shareholders agreement contain?
While the appropriate terms for a shareholders agreement will depend on the nature of the company, the industry and the interests of shareholders, some key terms that should be included are:
- Decision-making. What happens where you have only two shareholder/directors and they disagree? This means a deadlock on the board that needs to be resolved in some matter. Note, any provision in the shareholders agreement should be consistent with what the company constitution says about the matter.
- Voting. What are the voting rights of shareholders? And when can they intervene in company affairs? For example, is shareholder agreement required to approve a sale?
- Dividends. Under what conditions will dividends be issued, and which classes of share will they apply to?
- Issuance of shares. When can new shares be issued? What are the other proposed mechanisms for raising capital?
- Sale. When can the shares in the business, or key assets, be sold. How will the valuation work? It is common for agreements to provide a mechanism giving other shareholders a ‘right of first refusal’ when one shareholder wishes to sell their shares. There may also be some prohibitions on who shares can be sold on to, such as company competitors.
- The link between ownership and governance/employment. It is common for large portions of shareholding to be held by key employees or directors. When those employees or directors leave, you may seek a mechanism requiring them to sell their shares, stopping them from profiting from the company despite no longer being actively involved in it.
- Disputes. How will disputes between shareholders be managed? Will they go to mediation or binding arbitration? Who pays for it?
- Default and insolvency. What happens when the company defaults on its obligations, goes insolvent, or otherwise needs to appoint an insolvent professional? For more information on the shareholder role in liquidation read our comprehensive guides to liquidation in Australia.
- Solvent winding up of the company. How is the business to be wound up voluntarily?
Conclusion: The value of a shareholders agreement
In smaller businesses in Australia there can be a tendency to be overly casual and let formal agreements slide. This is a mistake. The shareholders, as the ultimate owners of the business, have more power over the company than anyone. Not having a shareholder agreement in place means being vulnerable in the (quite likely) scenario that disagreements between shareholders arise at some point.
When putting together the founding documents of the company, including the company constitution, it is worth considering the value of a shareholders agreement.