• A shareholders agreement is an agreement made between two or more shareholders, independent of the company’s constitution or contracts in which the company is involved.
  • The agreement may contain clauses on the roles and responsibilities of shareholders, how your company will be managed, how disputes are to be resolved, the rules and requirements around new share issues, selling shares, and how to handle a takeover offer.
  • A standard company constitution will not always protect you and your shareholders in the event of a dispute between shareholders and members. You should individually tailor your shareholders’ agreement because every company is different.

Why Have a Shareholders Agreement?

The specific provisions of each shareholders agreement should take into account the number of shareholders, the objectives of the shareholders, the funding arrangements, and the nature of the business or industry in which the company operates.

A company’s internal management will be governed by a combination of:

  • the Corporations Act 2001; and
  • the company’s Constitution, if it has one; and
  • the company’s Shareholders Agreement, if it has one.

The Corporations Act

The Corporations Act provides some basic safeguards for shareholders but does not adequately cover the rights of shareholders in detail. Although the Corporations Act does not require companies to have a Shareholders Agreement, having one can be beneficial for setting ground rules about issues that affect shareholders.

Additionally, the Corporations Act provides that a set of rules, known as the Replaceable Rules, apply to private companies in certain circumstances. These rules will apply to your company if you registered it before 1 July 1998 and have repealed its constitution since that day. Replaceable rules also apply if you registered your company after 1 July 1998.

Types of Shares 

A company can issue different types of shares to individual shareholders. You can issue shares according to their categorisation into different ‘classes.’ Each share class has various rights and restrictions attached to it, which differentiates it from other classes. Common titles for share classes are ordinary, preference, class A and class B shares. A company can elect to choose their own titles for different share classes. A Shareholders Agreement will set out the rights and restrictions placed on different classes of shares. 

A company can also issue different types of shares. Common types of shares include: 

Preference sharesPreference shares entitle the shareholder to a fixed dividend, whose payment of the dividend takes priority over that of ordinary share dividends. In the event of company bankruptcy, preferred stock shareholders have a right to be paid from company assets first.
Redeemable preference sharesRedeemable preference shares may be redeemed at a specified time such as a members’ option, a fixed date, or at the passing of a particular event. These shares are governed according to their prescribed terms of issue.
Bonus sharesBonus shares are issued with no fee payable to the company. The issue of these shares does not increase the company’s share capital. 

Key Clauses to a Shareholders Agreement

Every shareholders agreement is different; however, there are several key clauses every agreement should have.

Directors and the Board

A Shareholders Agreement can set out the maximum number of directors and the percentage of shares required to appoint a director. It should also contain a clause on when and how you can remove a director, for example, if they commit an ‘Event of Default.’

Board Meetings

The frequency of board meetings, as well as who can call for a directors meeting, are essential. These meetings should be quarterly and more frequently as agreed. The Agreement should include the quorum, being the minimum number of directors required to be present at a board meeting.

Duties of Directors

The Corporations Act and general law set out the duties of directors. The Agreement can set out the key duties and additional duties, including to:

  1. represent the interests of the shareholders;
  2. avoid conflicts of interest;
  3. discharge all duties with due care and diligence;
  4. not use their position, or information obtained from their position, to gain an advantage for themselves; and
  5. not cause detriment to the Company.

Shareholders Meetings

A general meeting is a meeting of the shareholders of the company. A Shareholders Agreement should set out what issues the shareholders decide, rather than the directors.

Deadlocks and Disputes

Where shareholders cannot agree on the management of the company, a deadlock provision resolves this. A Shareholders Agreement should set out how to resolve disputes, including how to resolve a deadlock between the directors or the shareholders. This may include a direct meeting and mediation.

New Shares and Dividends

An issue of new shares requires either unanimous approval or majority approval of shareholders. The Shareholders will often need that new shares are first offered to existing shareholders on a pro rata basis.

Regarding dividends, a Shareholders Agreement will include how the directors of the Company will determine that a dividend is payable, and they also fix the amount, time and method for payment. In addition, the Agreement should state whether dividends the Company declares will be unfranked, partly franked or fully franked.

Employee Share Schemes

A Shareholders Agreement should include the process for how to issue new shares. Employers use employee Share Schemes to incentivise key employees by issuing them with shares over the time of their employment based on agreed performance targets. A Shareholders Agreement should provide for this process. 

Transferring and Selling Shares and Takeover Offers

A Shareholders Agreement should outline how a shareholder can sell his or her shares. This will require notice in writing to other shareholders and the option of purchasing the shares pro rata in proportion to their existing shareholding. The method of valuing the shares needs to be set out. For example, set out a valuation formula, or that an independent accountant will value the company.

Key Takeaways

An agreement may provide that some decisions by the company such as mergers or acquisitions require special rules or provisions. By contrast, you can delegate day-to-day decisions or determine them through a majority vote. There is no golden rule on how voting or decision-making power should be based on an equity holding or a per partner/director basis. Relevant parties within a company will need to agree to determine this.

If you are using an incorporated ‘quasi-partnership’ or other incorporated joint venture, you should not rely exclusively on the provisions of the Corporations Act and the company’s Constitution. Instead, you should enter into a Shareholders Agreement to more fully and carefully define your rights and obligations.

Frequently Asked Questions

What is sweat equity?

Sweat equity is the time and effort that people contribute to a project, with no financial input from the contributors.

What is vesting?

Share vesting occurs when a shareholder acquires full ownership of shares. A share is considered vested when the employee may leave the job, yet maintain ownership of the share with no consequences.

What is drag along?

Drag along is where the majority shareholder(s) can require the minority shareholder(s) to sell, so that the bidder can buy the whole company.

What are tag along?

The Shareholders Agreement can include that if there is a takeover offer, and the majority shareholder(s) want to sell, the minority shareholder(s) can ‘tag along’ and sell their shares to the bidder at the same price.

How can LegalVision help me?

Do you require a Shareholders Agreement? We’ve helped many founders, and it would be our pleasure to assist you. We provide a free initial assessment and fixed prices for your certainty and peace of mind. LegalVision provides businesses and individuals with tailored online legal advice, including drafting and reviewing Shareholders Agreements.

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