The importance of a well written Shareholders Agreement
When starting a new company, take the time to consider and prepare a detailed Shareholders Agreement as it can help to avoid costly problems in the future. Usually directors and shareholders of a company begin with a shared vision of their new business, however views often change over time.
For example, if your company starts to generate significant profits and you and your directors and shareholders cannot agree on how those profits should be applied. Should those profits either be taken as a dividend and paid to the shareholders or should those profits be reinvested within the company and used as working capital to grow the company?
When a company is incorporated, people will usually prepare a standard form company Constitution. However, this Constitution will not cover all of the issues that a new business is likely to be confronted with. It usually does not set out in detail the specific intentions of the shareholders with respect to managing the new company’s vision. A company Constitution can typically be amended by a 75% resolution of the voting shareholders. In contrast, a Shareholders Agreement will usually require a unanimous resolution for any amendments to the Shareholders Agreement.
The Corporations Act 2001 (Cth) provides some form of regulation of the relationship between the company, its directors and its shareholders. But it may not provide the level of protection that shareholders typically require when investing in a new business.
An example under the Corporations Act 2001 is that a director can only be appointed with the approval of the majority of shareholders. However, investors and shareholders may prefer that each significant investor holding a minimum threshold of shares in the company has a right to have a director appointed to the board as its representative. A well drawn Shareholders Agreement can help define the expectation of all parties from the outset, including with respect to issues of breaching the obligations of directors and shareholders and with respect to the exit plans of shareholders.
A well-drawn Shareholders Agreement should set out the specific rights and roles of each shareholder. It should leave little room for misunderstandings between the shareholders as to what will happen if the business does not progress as expected. For example, it may specify that particular shareholders require board appointments irrespective of their shareholding.
It can also stipulate “tag along mechanisms” that apply with respect to the sale of shares in certain situations where shareholders may be forced to sell their shares (example death, insolvency, termination of employment). A usual feature of Shareholders Agreements is that they contain a pre-emptive rights clause, which gives shareholders the right to maintain the proportionate shareholding through successive capital raises by participating in the process (pro-rata to their existing shareholdings).
A Shareholders Agreement can also provide for the remaining minority shareholders to be forced to sell their shares in the event of the majority of shareholders deciding to sell the company to a third party. This assists with making the private company more marketable because the majority shareholders can deliver all of the issued shares to a potential buyer.
Where shareholders in a company begin to have disagreements, the Shareholders Agreement can provide for a mechanism to facilitate the resolution of those disagreements and, failing resolution, for the valuation and transfer of the party’s shares to the other shareholders. If you are looking to set up a new company to operate a business, consider the following:
- Key goals for your business – whether it has the intention to sell the business in the short term, or to run on a long term basis to generate income.
- Explore with the other shareholders their expectations for the direction of the company.
- Clearly describe the roles and contributions of each shareholder and director.
- Negotiate a Shareholders Agreement at the outset when the company is incorporated. Ensure the company’s Constitution is formally amended to ensure it is consistent with the Shareholders Agreement.
- Over time, the above issues become more important as the company’s value increases. A Shareholders Agreement is an essential document for all shareholders to understand how they plan to operate the business and ultimately to exit the business.