After setting up your company, it is important to understand the legal requirements involved in running it. Two critical documents that play a crucial role in governing a company are the company constitution and shareholders agreement. But do you need one, both, or neither? In this article, we explore the relationship between these two documents and why they are essential for your business.
What is a Company Constitution?
When running your company, you need a formal set of rules that govern the internal management of your business.
The replaceable rules are a basic framework for a company to adopt as part of its internal governance structure. When you first incorporate a company, you will often rely on the replaceable rules as your governing principles before adopting a company constitution.
When adopting a constitution, a company can choose to exclude all replaceable rules in favour of the constitution’s rules or exclude only some replaceable rules. Replaceable rules will apply unless otherwise stated or provided for in the constitution.
A company constitution and the replaceable rules act as a contract between:
- the company and each shareholder;
- the company and each director and/or company secretary; and
- two shareholders.
There is no prescribed form that a written constitution should take. Instead, this will depend on what your shareholders decide are the needs of the business. The written constitution typically addresses day-to-day management matters, including:
- the appointment, powers, and removal of directors;
- organisation and calling of both directors’ meetings and shareholder meetings;
- issuing shares; and
- dispute resolution.
Adopting or amending a constitution requires a special resolution by at least 75% of the votes cast by the shareholders.
What is a Shareholders Agreement?
A shareholders agreement is an agreement between each shareholder and the company.
Most commonly, shareholders invest in the business by providing money in return for part ownership in the company (shares). A shareholders agreement aims to protect the shareholder’s investment and establish their rights and obligations in ways that promote shareholders working together to grow the business.
Shareholders agreements will vary in content depending on the circumstances of the company and their shareholders. However, some standard clauses that are usually found in an agreement include the following:
- composition of the board of directors;
- rights and ability to issue new shares;
- payment process and calculation of dividends;
- process of transferring shares either to other shareholders or third parties;
- events of default and what happens in the event of one;
- how major decisions are made; and
- method of dealing with deadlocks and disputes.
Specific terms of the shareholders agreement will depend on multiple factors. However, there are some additional points that you should consider, including:
- the nature of the business;
- the potential for growth;
- future third-party financing;
- drag along and tag along rights;
- vesting arrangements;
- employee share option plans; and
- any other matters particular to the industry the business is in.
Conflicts Between Shareholders
Conflicts can arise between minority and majority shareholders. A minority shareholder is one who does not exert control over a company. In contrast, a majority shareholder almost always exercises control over:
- the company;
- its internal management;
- the board of directors; and
- other fundamental business matters.
A minority shareholder may want to include provisions in the shareholders agreement that protect their right to participate in the decision-making process.
Conversely, majority shareholders look to include provisions that give them the flexibility to make company decisions without the minority shareholders having input. Therefore, you must consider these issues when drafting your shareholders agreement.
Continue reading this article below the formHow Does a Constitution and Shareholders Agreement Work Together?
At first glance, a shareholders agreement and a company constitution provide similar functions regarding the rights and obligations of the company’s associates. So, what are the similarities and differences, and why does your business require both documents?
Company constitutions:
- are mandatory unless a company chooses to use the replaceable rules;
- are often high-level governance documents that focus on the directors and secretaries of the company; and
- can be modified by less than unanimous agreement between members (usually 75% by way of a special resolution).
Whereas a shareholders agreement:
- is an optional and confidential document between the shareholders and the company;
- is specific to the company’s circumstances and internal arrangements;
- provides a framework for existing and incoming shareholders to maintain consistency in their roles and allows shareholders to work together to achieve growth for the company; and
- in contrast to a constitution, even a very small change to a shareholders agreement may require unanimous consent (resolution of 100%).
While a company constitution provides the fundamental framework for a company’s operations and governance, a shareholders agreement offers flexibility and customisation to address specific shareholder relationships and needs. Both documents play essential roles in ensuring clear communication, effective decision-making, and the smooth functioning of a company.
This guide will help you to understand your corporate governance responsibilities, including the decision-making processes.
Key Takeaways
The company constitution and shareholders agreement play critical roles in the governance of your business. While they serve similar purposes, each document serves a unique function and is necessary for a successful operation. Whether you are starting a new business or have an existing company, it is crucial to understand the relationship between these two documents and their importance in protecting your investment and growing your business.
A company constitution governs the internal management of your business. In comparison, a shareholders agreement guides the relationship between shareholders.
If you need assistance reviewing, drafting, or understanding your company constitution or shareholders agreement, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to solicitors to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
We appreciate your feedback – your submission has been successfully received.
