As your startup grows and moves into the next phase, you may decide to finance your business through some form of third-party funding. If you have chosen to raise capital by issuing shares in your company in return for money, it is prudent that you speak with a lawyer about drafting a shareholders agreement. Just as no two companies are identical, no two shareholders agreements are either. It is important that the shareholders agreement reflects the way in which the shareholder envisions how the company will be organised and managed. There are, of course, standard clauses typical in shareholders agreements. Below, we set out what is a shareholders agreement, why you need one and a checklist for what it should cover.
What is a Shareholders Agreement and Why do I Need One?
A shareholders agreement is a legal instrument governing the relationship between the shareholders of a company. Shareholders hope to receive a return on their investments, and the shareholders agreement sets out ways in which shareholders work together to grow the business. It is commercially sensible to enter into a shareholders agreement, even if your shareholders are friends and family. Although nobody likes to imagine their relationship deteriorating, it’s best to determine at the outset how parties will resolve any disputes.
What Should a Shareholders Agreement Cover?
A shareholders agreement typically addresses the following:
- The relationship between the directors of a company and the shareholders;
- Issuing shares;
- Payment of dividends;
- Selling shares (either to other shareholders or third parties); and
- Dealing with deadlocks and disputes.
Your Agreement should also include the nature of the business, the potential for growth of the business, future third party financing and any other matters particular to the industry.
What Should a Shareholders Agreement Cover?
1. Operation and Management of the Company
It is important to consider how the shareholder and directors work together. Shareholders agreements will usually confirm that the directors will operate the company, and their decisions are binding. A director (or, if there is more than one, the board of directors) will be responsible for the day-to-day management of the company.
Importantly, directors must comply with certain duties as set out in the Corporations Act 2001 (Cth) as well as common law. If any director has breached these duties, they may be found personally liable for the actions of the company.
Shareholders agreements may also set out the relationship between the shareholders and the directors including:
- The requirement to provide financial documents and other duties;
- Director’s remuneration;
- Appointment and resignation of directors;
- Meetings of the board of directors; and
- Shareholders meetings.
It may also set out the matters which the board of directors will decide or which require shareholder approval.
2. Issuing New Shares
A shareholders agreement will set out the process of issuing new shares in the company. The company may issue shares for various reasons, for example, requiring more capital by way of a financial injection into the business, or giving incentives to key employees. Remember with each new share issue in your business, you are diluting your ownership in the company. When including this clause in your agreement, you should consider what is the approval process to agree to issue new shares, the prices of the new shares, how many are on offer and to whom.
If the company offers the shares to a new third party shareholder, then the new third party shareholder will need to execute and deliver a deed to the company of accession. The deed in effect binds the new shareholder to the terms of the original agreement. Signing a deed of accession eliminates the administrative hassle of entering into a new shareholders agreement each time the company issues shares in the company.
3. Return on Your Investment: Dividends
You will need to consider competing interests when distributing or sharing profits – does the company decide to keep the profits to grow the business or pay dividends to shareholders. If the company decides it will pay dividends to shareholders, then the shareholders agreement will set out how, when and the method of payment. A shareholders agreement will also state whether any dividend will be unfranked, or partially or fully franked. A fully franked dividend effectively means that the shareholder can benefit from the tax the company has already paid in respect of the dividend.
4. Selling or Disposing of Shares: How and to Who?
Another important matter to consider is the exit strategy for shareholders – are there any restrictions on their rights to sell their shares? Imagine all the shareholders in the company have a falling out with one shareholder. This shareholder decides to sell his shares in the company (for practically nothing) and goes directly to a competitor – less than ideal!
A well-drafted shareholders agreement will address how a shareholder can dispose or sell their shares and the price or mechanism for determining the price of the shares. There may be “drag along” and “tag along” clauses which deal with the situation where someone outside of the company wants to purchase the company. These clauses set out the rights of the majority shareholders as well as the rights and protection of the minority shareholder if there is a takeover offer.
5. Dealing with Deadlocks and Disputes
It makes business sense to set out the manner to deal with difficult situations in your shareholders agreement (i.e. fights between shareholders/directors and decision deadlocks) before they arise. It’s then sensible to decide from the outset how to resolve disputes or deal with a board of director/shareholder deadlocks.
A shareholders agreement is an important document for a company. It should set out clearly the agreement between the shareholders and their relationship with the directors and the company. Although no two shareholders agreements are the same, there are common clauses you should look out for. If you have any questions, get in touch with our commercial lawyers on 1300 544 755.
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