What Is a Shareholders Agreement and Why Every Business Needs One

Do I need a shareholders agreement?

The short answer, yes. A shareholders agreement is a legal document that sets out the rules and processes which apply to the shareholders of a company, determines the rights and obligations of shareholders, and governs the relationship between company directors and shareholders.

The purpose of a shareholders agreement is to avoid disputes between shareholders, reduce disruption to the business of the company and to ensure the continued and seamless operation of the company in the event a shareholder wishes to sell or acquire shares.

What is the difference between a shareholders agreement and a company constitution

A shareholders agreement applies in addition to (or may override in certain circumstances) the company constitution. When drafted properly, a shareholders agreement will consider the specific shareholders of the company and address a wide range of issues that might arise between them. On the other hand, a company constitution is usually a more standardised document containing general, high-level rules about company governance.

A company constitution can be replaced by a 75% shareholders vote, but a shareholders agreement can only be replaced with the consent of all the parties to the shareholders agreement. Therefore, a shareholders agreement is especially important for protecting minority shareholders who would otherwise be at risk of being controlled by majority shareholders.

What is the difference between a shareholders agreement and the Corporations Act 2001 (Cth)

A shareholders agreement also applies in addition to the Corporations Act 2001 (Cth) (the Act). In the absence of a shareholders agreement and/or a company constitution, the Act provides basic safeguards to shareholders in the form of the Replaceable Rules. The replaceable rules cover a range of commercial law matters, including, but not limited to, the conduct of board meetings, appointment and removal of directors, powers of directors and the rights of shareholders to inspect company books.

The replaceable rules apply unless otherwise provided for by the company constitution and/or the shareholder’s agreement. While they may be useful, the replaceable rules only provides a basic framework for corporate governance and basic safeguards to shareholders. Unlike a company constitution or shareholders agreement, they are not tailored to reflect the specific needs of a company.

What might be included in a shareholders agreement

Why shareholders agreements can be so crucial is that important clauses may be included, such as:

Pre-emptive rights

Pre-emptive rights allow existing shareholders to acquire shares prior to those shares being offered to third parties. Common types of pre-emptive rights are:

a. Right of first refusal:

A shareholder who wants to sell their shares must first offer those shares to other shareholders in proportion to their current shareholding. The exiting shareholder can only offer the shares to a third-party buyer if the existing shareholders choose not to buy them.

b. Right of last refusal:

An exiting shareholder who has found a third-party buyer is required to give other shareholders an opportunity to match the price before it can sell those shares to the third party.

Restraints

A shareholders agreement may include restraints in order to prevent a shareholder from competing with the company or soliciting the company’s clients. Generally, these clauses apply whilst a person is a shareholder of the company and for a specified period of time after a person ceases being a shareholder of the company.

Deadlock/Stalemate

These provisions are enlivened when decision making stalls resulting in a deadlock or stalemate. They set out a process for resolving the impasse, allowing the company to then move forward. There are numerous procedures that can be employed for this purpose, a shareholders agreement should identify the option best suited to the continued operation of the company.

Tag along/Drag along

Tag along rights are the rights of minority shareholders to have their shares purchased for the same price and on the same terms as a majority shareholder. The intent is to protect minority shareholders should a majority shareholder exit the company, leaving minority shareholders stranded.

Drag along rights compel minority shareholders to sell their shares to genuine buyers at the same price and on the same terms as a majority shareholder. They are beneficial to the majority shareholder wishing to incentivise a potential buyer by offer of the entire company.

Buyouts

Buyout mechanisms address exit strategies, or provide for the sale of the business, and may also include how and for what value a shareholder may exit the company.

Reserved matters

There can be particular kinds of decisions which may impact upon a shareholders investment, and in those circumstances the decision-making can be shifted away from the board of directors to the shareholders, requiring approval from a special majority of shareholders.

Safeguard your business

If you’re ready to protect your business and ensure all shareholders are on the same page, contact Lewis Kitson Lawyers today. Our experienced team can guide you through the process and create a customised shareholders agreement tailored to your needs.