A shareholders agreement explains how the company will be run, how decisions will be made, and what happens when shareholders disagree or someone wishes to exit. It governs all of the key aspects of the relationship between a company's shareholders.
If you don't have a shareholders agreement, your rights and obligations will be regulated by the company's constitution, the Corporations Act and the general law. People enter into shareholders agreements so that:
- their rights and obligations are all set out in the one document;
- they have certainty about what their rights and obligations actually are; and
- they can record agreements that are relevant to their specific circumstances.
What does a shareholders agreement cover?
- The company's scope and purpose.
- How directors are appointed.
- How decisions are made.
- When shares can be issued and sold.
- How disagreements will be resolved.
- Shareholder rights to information.
- Miscellaneous other provisions.
The company's scope and purpose
Defining the company's scope and purpose is important to ensure that all shareholders join the venture on the same page. These provisions can often set limits on what the Board is able to do without shareholder approval.
For example, if the shareholders are associating themselves to establish a new construction company, the shareholders are entitled to expect that the company's resources will not be used for some unrelated purpose.
How directors are appointed
As a shareholder, you don't automatically have the right to appoint a director. If you wish to have such a right, it will need to be included in the shareholders agreement.
Otherwise, the default position is usually that directors are appointed in general meeting by a majority of shareholders. Whether this default position applies to your company will depend on its constitution.
How decisions are made
Shareholders agreements usually specify different levels of approval for different types of decision.
For example, some decisions might be left to the CEO or managing director, whereas others might require the unanimous approval of all shareholders.
A shareholders agreement will normally contain a list of the different types of decision, specifying (for each) what types of approval is required.
Examples of the types of decision normally covered are:
- borrowing money or entering into contracts above a certain value;
- buying a new business, or selling a substantial part of the existing business;
- issuing new shares; and
- terminating the employment of senior staff members.
If you would like to know more, there is a sample decision-making matrix in our comprehensive guide to shareholders agreements.
When shares can be issued and sold
Shareholders usually wish to avoid their proportionate stake in the company being reduced (or 'diluted') by the issue of new shares. Consequently, shareholders agreements normally contain rules about when new shares can be issued. Often, shareholder approval will be needed.
At the same time, shareholders in private companies usually wish to control the people (or classes of people) that may be allowed to participate in the venture. Unlike a listed company, shares in private company cannot be easily bought and sold.
Shareholders agreements normally contain pre-emptive rights clauses and other provisions that prevent shareholders from selling their shares to third parties. They also often contain 'tag along' and 'drag along' provisions that allow shareholders to effect or participate in joint sales.
How disagreements will be resolved
Without a shareholders agreement, disagreements between shareholders can sometimes end up in court. To minimise the potential for litigation, and with a view to minimising the impact of any disputes on the business itself, shareholders agreements will often contain provisions designed to ensure the smooth resolution of disagreements.
Some agreements will require good faith negotiation or mediation. Some may require a decision to be made by an independent third party, such as where there is a dispute over the value of a parcel of shares.
Sometimes the agreement will include a mechanism that will allow one shareholder (or a group of shareholders) to buy out the others. These types of provisions can work in a number of different ways, as explained here.
Particularly where shareholders have outside interests in the same or a related industry, shareholders agreements will contain restraints to minimise the risk of a shareholder putting their interests before those of the company or the other shareholders.
There are different types of restraints. The main ones are aimed at preventing a person from:
- poaching employees from the business;
- soliciting clients or customers away from the business; and
- engaging in competition with the business.
Any restraint provision needs to be carefully prepared having regard to the legitimate interests of the company and its shareholders. Otherwise they run the risk of not being enforceable.
Shareholder rights to information
It may come as a surprise, but shareholders' rights to receive information about the company and its performance are relatively limited. Unless you are a director of the company, you should not expect to receive regular updates or reports.
The general idea of this rule is to ensure that management is able to focus on running the company without being distracted by the shareholders.
If, as a shareholder, you wish to be notified of specific events or you require some type of ongoing reporting, this would need to be recorded in your shareholders agreement.
The list above covers the main points that are usually contained in a shareholders agreement. However they are by no means the only ones. You can read about other provisions in our guide to shareholders agreements.
It's also important to note that shareholders agreements are, or at least should be, company-specific. There are a number of reasons why should be wary of any shareholders agreement template.
That is, a good shareholders agreement needs to be prepared having regard to the position of each shareholder and the nature of the relationships between them. For this reason, there is no 'one-size fits all' approach. The contents of your shareholders agreement should depend entirely on the specific circumstances of your venture.