When starting a business through a company, most shareholders are focused on growth and success, not what might happen if things don’t go to plan.

However, as a business evolves, disagreements can arise, shareholders may wish to exit or buy in, and unexpected events can impact the shareholders, directors or the company itself. 

A Shareholders Agreement is a contract between a company’s shareholders that can address key matters such as decision-making, funding, disputes, events of default and restraints. Without one, disputes can become costly and difficult to resolve, with shareholders finding themselves in a deadlock with no clear or practical way forward. 

 

but we have a constitution? 

 

Shareholders Agreement vs Constitution

While a Shareholders Agreement and company constitution operate similarly, they usually serve different purposes:

shareholders agreement  company constitution 
a private tailored agreement for the business addressing the purpose of the company and wishes of shareholders  a statutory rulebook for corporate governance, with broad provisions relating to governance 
an agreement between each shareholder, key person and director of the company  a contract between the company and its shareholders 
focused more on protecting the business and outlining commercial terms such as funding, restraints, exit strategies and disputes  focused more on regulating the affairs of a company, such as share classes and the rights attached to shares 
drafted in the form of a binding agreement  can be governed by a constitution, the replaceable rules set out in the Corporations Act 2001 (Cth) (Act), or a combination of both

While the Act provides a framework for governing private companies, including a number of replaceable rules that apply unless modified or displaced by the company’s constitution.

These default rules may not reflect the commercial arrangements or intentions of the shareholders and do not capture all items that a Shareholders Agreement could cover. 

 

so, what does a shareholders agreement cover? 

 

1. decision-making and voting 

A Shareholders Agreement should establish how decisions are made within a company.

Decision-making provisions are often divided into different approval thresholds, commonly being ordinary decisions [typically more than 50% shareholder approval], special resolution decisions [typically 75% shareholder approval] and unanimous decisions [all shareholders must approve].

It is important that shareholders discuss and identify what matters should fall within each category.
Types of decisions could be: 

  1. issuing new shares in the company; 
  2. changing the company constitution; 
  3. the company executing any contract over a certain monetary value; 
  4. the company incurring any debts over a certain amount; 
  5. rebranding; 
  6. selling all or a significant amount of the company’s business assets.

Clearly outlining decision-making and voting thresholds helps prevent uncertainty and ensures shareholders understand how decisions are made. It can also provide protection for minority shareholders by preventing significant changes to the company from being made without their consent. 

 

2. voluntary transfers and exit

Addressing what happens when a shareholder wants to buy or sell shares in the company is an important provision to include in any Shareholders Agreement.
This can include, for example: 

  1. Pre-emptive rights: requiring shares to first be offered to existing shareholders in proportion to their shareholdings [or one founding shareholder first] before they are sold to a third party.
  2. Valuation: how shares are valued when parties cannot agree on a price.
  3. Permitted transfers: allowing transfers in certain circumstances, such as to a related entity or legal personal representative.
  4. Transfer restrictions: requiring shareholder approval before a shareholder can transfer their shares. 
  5. Third party: if shares are sold to a third party, whether this third party must be approved by the shareholders.

These provisions give shareholders greater control over who can become a shareholder and provide a clear process for shareholders who wish to exit the company.

This should also be considered alongside the company’s constitution and the applicable provisions of the Corporations Act 2001 (Cth), which contain rules governing the transfer and registration of shares. 

 

3. events of default and trigger sales 

It is important for a Shareholders Agreement can also deal with forced shareholder exits or sales, and distinguish between “Good Leaver” and “Bad Leaver” events and how each type of exit will be treated, such as: 

good leaver events  bad leaver events 
  • death 
  • permanent incapacity 
  • resigning or ceasing to be employed by the company, provided it was not due to a Bad Leaver event 
  • retirement at a certain age and exiting the industry 
  • fraud, theft or serious misconduct involving the company 
  • a shareholder or their key person being charged with an indictable offence
  • a material breach of the Shareholders Agreement which has not been remedied, such as a breach of their confidentiality or restraint obligations 
  • conduct that would warrant summary dismissal [if an employee], or resignation to commence a competing business 

Quite often, a Shareholders Agreement will provide different purchase price mechanisms depending on the type of exit.

For example, a Bad Leaver may incur a 25% discount on the purchase price for the sale of their shares, whereas a Good Leaver may receive market value.

The specific events, valuation methodology and any discount should be clearly defined in the agreement so that shareholders understand the consequences of each type of exit from the outset. 

 

4. dispute resolution 

A Shareholders Agreement should establish a clear process for resolving disputes between shareholders before they escalate. 

The agreement can set out a staged process, such as requiring shareholders to first attempt to resolve the dispute through good-faith negotiations, followed by mediation if unresolved.

Having an agreed dispute resolution process can help shareholders resolve issues efficiently and avoid unnecessary legal costs. It can also provide a clear way forward when shareholders reached a deadlock on an important decision. 

 

5. restraints

It is important to consider appropriate restraints to protect the company’s goodwill and business. These restraints may include preventing a shareholder from: 

  1. being involved in or working for a competing business, including within a specified area of the company’s business
  2. starting a competing business 
  3. soliciting, poaching or providing work to any customers of the company’s business
  4. using or disclosing the company’s confidential information
  5. detrimentally interfering with the company’s business or goodwill

It is also important that each shareholder’s key person [being the key person involved in the business on behalf of that shareholder] is subject to the restraints under the Shareholders Agreement. 

This is important where a shareholder is an entity, such as a company or trust, to ensure the restraints apply to the individual actually involved in the business. 

Restraints may apply also while the shareholder holds shares and should continue for an agreed period following the cessation of their shareholding [for example, three years]. The duration and scope of any restraint should be carefully considered and appropriately drafted, as restraints of trade are subject to legal limitations and enforceability considerations. 

 

6. confidential information and intellectual property

A Shareholders Agreement should clearly protect the company’s confidential information, such as but not limited to customer information, pricing, financial information, business strategies, intellectual property and other commercially sensitive information

It is important to clearly establish who owns intellectual property created in connection with the business, particularly where a shareholder or key person develops materials, systems, branding or other intellectual property.

The agreement should ensure that ownership is appropriately held by the company or otherwise clearly documented separately. 

 

the bottom line 

 

Ultimately, a well-drafted Shareholders Agreement provides clarity around how the business will operate and be managed.

By addressing these matters from the outset, shareholders can reduce uncertainty, minimise disputes, protect both the business and their individual interests, and focus on what matters most: growing a successful business. 

Every business and shareholder group is different, so the agreement should be tailored to reflect the particular structure, relationships and objectives of the business.

 

we’re here to help! 

Whether you are establishing a new company, adopting a Shareholders Agreement or reviewing your current one, our lawyers are here to help.
Reach out to our legal team on 1300 BDEPOT or email legal@businessdepot.com.au. 

 

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general advise disclaimer  

The information provided in this booklet is a brief overview of the subject matter and does not constitute any type of advice. We endeavour to ensure that the information provided is accurate however, information may become outdated as legislation, policies, regulations and other considerations constantly change. Individuals must not rely on this information to make a financial, investment or legal decision and should consult an appropriate professional before making any decision.