Why every company with two or more owners needs a shareholders agreement

When business partners set up a company together, they usually agree on the big things over coffee and leave the details for later. The details tend to arrive at the worst time: when one owner wants out, stops pulling their weight, falls ill or receives an offer for their shares. A shareholders agreement settles those questions while everyone is still on good terms.

What a shareholders agreement is

A shareholders agreement is a contract between the shareholders of a company, and usually the company itself, setting out how the company will be run and how ownership can change. It sits alongside the company's constitution, or the replaceable rules in the Corporations Act if the company has no constitution.

The constitution deals with the company's internal mechanics, such as how directors are appointed and how meetings are held. It is often a standard document and can be changed by a special resolution of shareholders. A shareholders agreement is a private contract that deals with the commercial deal between the owners. It cannot be changed without the parties' agreement, and it can cover matters a constitution typically does not.

Both documents should be prepared or reviewed by a lawyer, and they should be consistent with each other.

What happens without one

Without an agreement, the owners rely on the constitution and the general law. That can leave real gaps:

A shareholder can usually sell to anyone, unless the constitution restricts it, including to a competitor or someone the other owners do not know.
An owner who leaves the business can keep their shares and continue to receive dividends while contributing nothing.
There may be no agreed way to value shares when an owner wants to exit.
Two 50% shareholders who disagree can reach a deadlock, with no mechanism to resolve it short of court proceedings or winding up the company.
When an owner dies, their shares pass to their estate, and the remaining owners may find themselves in business with a family member who has no interest in running it.

The time to agree on how someone leaves is when nobody is leaving. A shareholders agreement is cheap compared with a dispute.

What it should cover

Decision-making

Who sits on the board and how directors are appointed or removed.
Which decisions the directors can make, and which need shareholder approval, often called reserved matters. Examples include borrowing over an agreed limit, issuing new shares, selling the business, changing the nature of the business or paying unusually large salaries.
The voting threshold for each reserved matter, such as unanimous or a set majority.

Roles and contributions

What each owner is expected to contribute in time, skills or capital.
How working shareholders are paid, separately from dividends.
Restraints on competing with the business or poaching staff and clients, which a lawyer should draft to be enforceable.

Funding

How additional capital will be raised if the business needs it.
What happens if one shareholder cannot or will not contribute their share, including dilution.
Whether shareholders can lend to the company and on what terms.

Dividends

A dividend policy, such as paying out an agreed share of profits after working capital needs, so that owners who rely on dividends and those who want to reinvest know where they stand.

Transfers and exits

Pre-emptive rights, giving existing shareholders the first opportunity to buy shares that are being sold.
Drag-along rights, allowing a majority that accepts an offer for the whole company to require the minority to sell on the same terms.
Tag-along rights, allowing a minority to join a sale by the majority on the same terms.
Good leaver and bad leaver provisions, setting different prices for an owner who leaves on good terms and one who leaves after a breach.

Trigger events

Death, permanent incapacity, bankruptcy, a serious breach, or ceasing to work in the business.
Whether these events require or allow the other shareholders to buy the affected shares.
How that purchase will be funded. Some owners consider insurance for this purpose; that is a matter for a licensed adviser and the agreement should reflect whatever is decided.

Valuation

How shares will be valued when a transfer is triggered: an agreed formula, an independent valuer, or a combination.
Whether a discount applies to a minority interest or a bad leaver.

Deadlock and disputes

A process for resolving disagreements, such as escalation, mediation, then arbitration.
A last-resort mechanism for a true deadlock, such as one owner offering to buy the other out at a stated price.

Getting the structure right first

A shareholders agreement works best alongside a structure that suits the owners. Many owners hold their shares through their own family trust or company rather than personally, which affects who signs the agreement, who is bound by restraints and how a sale is taxed. See Holding and operating companies: separating risk from assets and Discretionary (family) trusts explained.

If the co-owned business is held in a unit trust, the same issues arise and are dealt with in a unitholders agreement; see Unit trusts for co-owners and joint ventures.

When to put one in place

When the company is set up, or when a second owner joins.
When bringing in an investor, or offering shares to a key employee.
When buying into an existing business with other buyers.
Before negotiating a sale, if no agreement exists.
When circumstances have changed and the existing agreement no longer reflects how the business is run.

Questions to discuss with your co-owners

What happens if one of us wants to leave in two years?
What happens if one of us stops working in the business but keeps the shares?
How will we value the business if one of us buys the other out?
Which decisions do we each want a veto over?
How will we fund the business if it needs more money?

How we can help

We help co-owners work through the commercial and tax questions behind a shareholders agreement, including valuation methods, funding and how each owner should hold their shares, and we work with your lawyer, who drafts the agreement. To start the conversation, contact us or see our business structuring services.

This article is general information only and does not take into account your circumstances. Speak to a qualified adviser before acting on it.