Shareholders' agreements

Top tips

1. A shareholders’ agreement defines the terms on which business owners agree to be bound in their dealings with one another.
2. The agreement can be as simple or as complicated as shareholders choose, but best agreements include terms about how profit re-distribution decisions are made, new directors and shareholders are admitted, meetings are conducted, and deadlocks are broken.
3. Putting a shareholders’ agreement in place can save significant sums of money for shareholders that later fall into dispute about management matters.

What is a shareholders’ agreement?

A shareholders’ agreement is a contract between the owners of a business: the shareholders. It defines the terms on which the shareholders agree to be bound in their dealings with one another. A shareholders’ agreement is implemented in addition to the formal rules that govern a company, which are set out either in the company’s constitution, or by adopting the replaceable rules in the Corporations Act 2001 (Cth) (Act). The replaceable rules are generic provisions dealing with the very basic operations of company management.

Typically, public companies listed on the ASX do not have shareholder agreements, managing the relationship with shareholders through a formal shareholder engagement policy.

Why do I need a shareholders’ agreement?

Just like putting terms of agreement in writing with clients or customers, parties starting a new venture together should record in writing the way they want to deal with each other within the business and the best time to agree fair and equitable terms is at the beginning, when everyone is driven towards the joint success of the venture. A shareholders’ agreement is an essential tool to determining how the company is to be managed, including distributions of profit, appointment of directors, and the process by which shareholders join or leave the business.

Without a shareholders’ agreement, relationships between business owners are governed by the Act or by the company’s constitution, both of which can be woefully inadequate to deal with some of the more complex issues that arise in running a company. The inevitable consequence of unsatisfactory policies is significant cost to stakeholders to resolve many of the common issues and disputes that might eventuate. A lack of a shareholders' agreement can also cause difficulties when friends or associates fall out, shareholders need to cash in their shares for personal reasons or where there is a death, divorce or a relationship breakdown.

What terms are included in a shareholders’ agreement?

The most effective shareholders’ agreements are those that have clear, certain terms that look to achieve efficient resolutions to common problems. Shareholders’ agreements usually deal with the following issues, among others.

Directorships

There are several different types of directorships, and the role a person holds can significantly affect the way a company is managed. A shareholders’ agreement will commonly define who does what, and how directors of different types are appointed (for example, some agreements limit which shareholders can appoint directors). It can also provide how directors are removed or terminated in the event of disputes, wrong-doing or the exit of a shareholder.

Shareholdings

Like directorships, shares can be held in different ways, such as ordinary or preference shares, with various rights attaching to the different nature of shareholding. A shareholders’ agreement can distinguish between types of shares and the rights that attach to them, including voting rights, rights to share in profit distributions and the rights and obligations that arise when things go wrong (such as the company becoming insolvent).

Decision-making

Agreements will usually deal with decision-making by allowing shareholders to appoint directors to a board, and then setting requirements for majority or unanimous voting on particular matters. It is common for a company to identify a list of decisions that require all directors or shareholders to vote unanimously on a resolution, and others that require only simple (50%+1) or special majorities (75%).  Examples of decisions that require unanimous voting might be the issue or creation of additional shares or classes of shares and incurring expenditure, or taking loans, over a certain amount. Decisions that change the nature of the company generally require approval by a special resolution of the shareholders. Some examples include: modifying or adopting the company constitution, changing the company's name, changing the company share structure or changing the company type.

Meetings

While a company’s constitution, or the replaceable rules, often make basic provision for the process of calling a meeting, shareholders’ agreements permit more specific provisions to be made about the calling, and voting at, board meetings and shareholder meetings.

Distributions

The distribution of profits is the way shareholders make money from their investment in the business. It is also where taxation implications arise and, unfortunately, where disputes are commonly founded. It is therefore imperative that shareholders reach and record their agreement on matters relating to the company’s profits, such as how it is to be retained, reinvested and distributed, who has the right to receive a dividend (particularly if there are different classes of shares), and when the dividends will be distributed.

Incoming/outgoing shareholders

Stakeholders can agree the process and include terms such as requiring a selling shareholder to give existing shareholders the first right of refusal to purchase the shares, allowing a majority shareholder to ‘drag’ along minority shareholders in a larger share sale, or allowing a minority shareholder to ‘tag’ along on such a sale. Importantly, the shareholders’ agreement can set out how the share price is to be determined for a sale or purchase of shares.

Deadlocks

A shareholders’ agreement can define who gets a casting vote on any decision where shareholders are split down the middle. There are various methods of resolving deadlocks, and it is better to agree which one will be used well in advance of the stalemate occurring.

Disputes

Dispute resolution provisions in shareholders’ agreements usually require the parties to go to mediation, arbitration, or expert determination before a party can commence litigation. Within the dispute provisions, stakeholders should identify what constitutes a breach of the agreement, and the consequences of breach, such as a forced sale, removing a shareholder or terminating the agreement.

How do I put a shareholders’ agreement into place?

Whether you are just getting ready to start a new venture, or if you have been in business for a while without a shareholders’ agreement, we encourage you to get in touch with one of our experts who can assist you with putting together an agreement that is tailored to suit the needs of your business, and how the owners want to interact with each other.