The shareholders of a company ultimately determine what to include in the company’s Shareholders Agreement. The types of clauses you should consider including will depend on a number of factors, including the type of business you’re looking to set up, the number of shareholders and the goals of the company.
LegalVision’s lawyers regularly draft Shareholders Agreements, and it’s fair to say that no Shareholders Agreement is completely identical to another. Set out below are the most common types of clauses we see in Shareholders Agreements.
Director and Management Structure
A Shareholders Agreement will almost always contain clauses which regulate the company’s directors and management structure. Generally, this will include clauses relating to decision making, the rights of shareholders to appoint or remove directors and the powers of the managing director.
Buy-sell provisions set out the rights and obligations of shareholders to buy or sell their shares in certain circumstances, including insolvency, disability, death or retirement. Generally, a price or valuation mechanism should be included.
Buy-sell provisions are often considered to be the most important provisions in Shareholders Agreements, particularly for minority shareholders in closely held private companies who may not otherwise be able to dispose of their shares.
Every Shareholders Agreement should specify how the shareholders will contribute towards the working capital of the business and the implications for any shareholder who does not contribute in proportion to their shareholding.
Share Transfer Restrictions
In smaller companies where there are few shareholders, Shareholders Agreements often contain detailed clauses restricting share transfers, so all the shareholders have some control over the identity of those with whom they are in business. Generally, share transfers are restricted by first requiring director approval or giving existing shareholders first rights to buy shares if another shareholder wants to sell them.
A Shareholders Agreement should set out the consequences for a shareholder who breaches it and contain a process for resolving disputes in the event of a dispute between the parties.
The terms of a Shareholders Agreement are generally confidential to the parties, unless they otherwise agree. A provision to this effect should be inserted into every Shareholders Agreement.
A Shareholders Agreement should permit or prohibit the shareholders of the company from contracting with the company. If contracting is permitted and there are any terms or restrictions that must apply to such contracting then these should also be specified.
Meetings of Directors and/or Shareholders
Most Shareholders Agreements regulate meetings of shareholders and directors. They generally proscribe how meetings must be called, how a quorum can be formed and procedures for holding meetings. In addition, a Shareholders Agreement should state when unanimous voting is required and when only a certain percentage of votes (e.g. 50% or 75%) is required to pass a resolution, otherwise the provisions of the Corporations Act 2001 (Cth) will apply.
These clauses state the procedure which needs to be followed before new shares are issued or transferred. In addition, each new shareholder is generally required to execute a ‘deed of accession’ so that they agree that the Shareholders Agreement is binding upon them when they become a shareholder of the company.
Some shareholders will only be shareholders, not directors, of a company. Shareholders may, however, be given ‘observer rights’ to attend board meetings (or certain parts of those meetings), but not vote.
Protecting the Company
Shareholders Agreements should contain clauses which protect the business interests of the company. For example, shareholders may be required to disclose conflicts of interest, restrained from being involved with competing businesses and have restrictions imposed on them in dealing with customers of the company.
Deadlock provisions deal with circumstances where shareholders cannot agree on a given course of action (i.e. the shareholders are deadlocked). This is particularly important where there are only two shareholders who each own 50% of the company’s shares.
There are a number of ways that a deadlock can be resolved, including:
- Russian roulette: meaning one shareholder has to buy the other shareholder’s shares or sell their own.
- Mediation: the shareholders must agree to mediation (or some other form of dispute resolution) to assist them in resolving their disagreement.
- Texas shoot-out: each shareholder will put in a sealed bid to buy the other shareholder’s shares and whoever places the higher bid must buy the other shareholder’s shares.
- Deterrence: Fixes a price where one shareholder has to buy the other person’s shares at 125% of market value.
Regardless of the method of resolution chosen, of utmost importance is that a method is specified so that the deadlock provisions work.
When entering into a Shareholders Agreement it is vital that the shareholders think carefully about how they want to run the company. It’s a good idea to model a variety of scenarios, particularly with regards to a future acquisition of the business. This will assist you in working out which provisions should be included in your Shareholders Agreement. Clearly it’s vital that you work with an experienced business lawyer to ensure that your Shareholders Agreement works effectively.