Why do I need a Shareholders Agreement?

Why do I need a Shareholders Agreement?

Allied Legal is a commercial law firm based in Melbourne.  Our firm’s Melbourne based commercial lawyers regularly advise and prepare shareholders agreements on behalf of clients.  Here is our take on shareholders agreements and why they are required.  If you require any assistance, please contact our Melbourne commercial lawyers at info@alliedlegal.com.au or call 03 8691 3111.

A shareholders agreement sets out the rights and obligations of the shareholders of a company. It is separate from the company’s constitution.

Are shareholders agreement a legal requirement?

No.  However, even though there is no legal requirement to have a formal shareholders agreement, every company with more than one shareholder is well advised to have one.  Shareholder agreements ensure that the running of the company and the responsibilities of the shareholders are properly thought through, there is clarity and certainty as to what can or cannot be done and decisions are taken by consensus and discussion.  As a result, it will reduce the potential for conflict between shareholders and help the company to be run smoothly and profitably.

Here are some other reasons for putting in place a shareholders agreement

Regardless of whether you will be a minority or majority shareholder, there are a number of reasons why you should have a shareholders agreement.

1. It will protect your interests as a shareholder.
2. It will ensure you are joining the commercial venture on the same page as the other shareholders.
3. It will give you certainty about the scope and extent of your rights and obligations as a shareholder.
4. It will give you a single reference point to determine your rights and obligations as a shareholder.
5. It will allow you to do things differently to the default position prescribed by law.

If you are a minority shareholder, there are a number of things you should look for in a shareholders agreement. For example, you may want the ability to appoint a director, you may require certain minimum rights to information, and you may want the ability to tag along with a larger shareholder if they decide to sell their shares.

Similarly, if you are a larger shareholder, you may want a first right over the other shareholders’ shares, you may want to ensure that minority shareholders cannot stifle decision-making, and you may want the ability to drag along the other shareholders into a sale.

A shareholders agreement is an effective way to address these issues.

What provisions does a shareholders agreement contain?

There is no one correct form of shareholders’ agreement and its content will always depend on the circumstances and what the shareholders agree.

Further, as stated above, different shareholders may want different provisions depending on how much of the company they own. For example, minority shareholders may be more interested in provisions that protect them from being marginalised from decision-making, and majority shareholders may be more interested in provisions that enable them to ensure they are not held to “ransom” by the minority.

Having said that, some of the usual matters that a shareholders agreement ought to cover are:

1. Shareholder funding/contributions

The shareholders’ agreement should specify how the shareholders fund the acquisition of their shares.  For example, some shareholders may contribute cash funding to subscribe for the shares, whereas other shareholders may transfer IP to the company in exchange for their shares, or others may contribute services in exchange. Shareholders may also decide shares are not all issued to the shareholders at the same time and that shares may be vested or issued over a period of time.

2. Director appointments

The shareholders’ agreement should specify their rights (if any) to appoint directors, the circumstances when they may lose that right (such as if their shareholding drops below a percentage) and provisions so that other shareholders may not remove another shareholder’s appointed director.

3. Management, obligations and information

The next important area to cover is management and shareholder obligations. The shareholders’ agreement should specify how the company would be managed and what type of decisions require either a majority (50%), special (75%), unanimous (100%) or other approval. For example, certain significant decisions of the company may require unanimous approval rather than a simple majority to ensure that the interests of the minority shareholders are not ignored. The flipside of this is that certain decisions may be effectively “vetoed” by the minority. Therefore, the shareholders should also consider appropriate methods for resolving deadlocks and disputes.

The roles and obligations of the shareholders should also be spelt out so that each shareholder is clear what is required of them and the level of commitment. Further, the shareholders’ agreement should provide for rights to access information and financial reports so that shareholders (particularly minority or those without director appointment rights) are clear what they are entitled to receive.

4. Dividends and financing

The shareholders’ agreement should specify the circumstances when dividends may be payable, such as whether or not past shareholders’ contributions have to be repaid first. Some shareholders’ agreements may also provide for broad terms on which shareholders have “first rights” to provide further funding before the company seeks external funding.

5. Transfers of shares

These are critical in a shareholders agreement, and usually include a set of pre-emptive rights, and “drags”, “tags”, “come along”, “me too” or other similarly named clauses that broadly provide for circumstances under which certain shareholders may require other shareholders, or are required by other shareholders, to participate in a sale to a third party. Shareholders may also consider whether a shareholder must transfer their shares if they no longer participate in the management/operations of the company, and if so, whether all or some of their shares are transferred and at what value.

6. Exit strategy

The shareholders’ agreement should also make clear and identify a general exit strategy, which could be a buy-out, listing, sale of the business, as well as provide for what would happen if certain shareholders want to exit, and the value at which they may exit.

7. Default

The shareholders’ agreement should set out a list of events of default and the consequences of default by a shareholder, including whether that shareholder is forced to transfer their shares, and if so whether the valuation would be at market or “fire sale” value.

8. Deadlocks and disputes

The shareholders’ agreement should set out the consequences if there is a deadlock or if a dispute cannot be resolved. Provisions that are sometimes seen in shareholder agreements include “shotgun” provisions where a party specifies a price at which it is willing to buy-out or be bought-out by the other shareholders. Other provisions include put and call options or sometimes even a forced wind up of the company.

When should a shareholders agreement be put in place?

Ideally, a shareholders agreement should be put into place when you become a shareholder. Two problems with dealing with it later are:

1. our bargaining position may erode over time; and
2. it runs the risk of being forgotten, and a dispute could arise before the agreement is signed.

Have further questions?

If you have further questions, please contact Allied Legal at info@alliedlegal.com.au or call 03 8691 3111.  Our firm’s Melbourne based commercial lawyers regularly advise and prepare shareholders agreements on behalf of clients.