What is a Shareholders Agreement?

A Shareholders Agreement is a binding contract which is entered into between shareholders of a company. It governs the relationship of the shareholders and specify who will control the company, how the company will be owned and managed, how shareholders’ rights may be protected and how shareholders can exit the company.

What should a Shareholders Agreement outline?

A Shareholders Agreement should outline the following:

  • the structure, management and direction of the business;
  • how responsibilities will be divided between the directors and shareholders;
  • how shareholders may acquire or dispose of shares;
  • how the company will be funded; and
  • what will happen if the relationship between shareholders comes to an end.

Is it legally mandatory to have a Shareholders Agreement?

To enter into or have a Shareholders Agreement is not a legal requirement. However, it is always advisable to have a Shareholders Agreement to avoid future disputes so that the company can function smoothly. Disputes generally occur when shareholders want to sell their shares or exit the company or if the performance of the company is not good. A Shareholders Agreement provides flexibility and the opportunity to tailor a contract as per one’s needs. Since the Shareholders Agreement can divide management functions by providing separate rights and obligations, it can be used as a kind of collaborative management tool.

What relevant clauses should a Shareholders Agreement contain?

A Shareholders Agreement should contain clauses which regulate the company’s directors and management structures. The general clauses should include (i) rights of shareholders to appoint or remove directors, (ii) powers of the managing director, (iii) decision-making clauses among others. The relevant clauses which should be contained in a Shareholder Agreement are as follows:

  • Buy and Sell Provision: Buy-sell provisions are often considered to be the most important provisions in a Shareholders Agreement. It sets out the rights and obligations of shareholders to buy or sell their shares in certain circumstances;
  • Financing: This clause sets out the method in which 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;
  • Restrictions on Share Transfer: Share transfers are generally restricted by first requiring director approval or giving existing shareholders first rights to buy shares if another shareholder wants to sell them;
  • Dispute Resolution: Consequences of breach and process for resolving disputes in the event of a dispute between the parties is a mandatory clause;
  • Confidentiality: The terms are generally confidential unless otherwise agreed between the parties. A provision to this effect must be inserted in the Shareholders Agreement;
  • Company Contracts: A Shareholders Agreement should permit or prohibit the shareholders of the company from contracting with the company. Any terms or restrictions to that effect must be specified;
  • Meetings: Clause relating to meetings must specify 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 will apply;
  • Accession Procedure: This states the procedure which needs to be followed before new shares are issued or transferred. A Deed of Accession is generally executed by a new shareholder so that they agree that the Shareholders Agreement is binding when they become a shareholder of the company;
  • Protection of the Company: A Shareholders Agreement must have clauses which protect the business interests of the company;
  • Deadlock: Provisions to resolve a deadlock (generally happens when there are only two shareholders who each own 50% of the company’s shares) must also be mentioned.

What are the advantages of a Shareholders Agreement?

There are various advantages or benefits of entering into a Shareholders Agreement, some of which are as follows:

  • A Shareholders Agreement protects the interests of the Shareholders;
  • It ensures joining the venture on the same page as the other shareholders;
  • A Shareholders Agreement gives certainty about the scope and extent of the rights and obligations as a shareholder;
  • It will give a single reference point to determine the rights and obligations as a shareholder;
  • It will allow one to do things differently to the default position prescribed by law.

A Shareholders Agreement enables the shareholders to apply their focus to promoting the company’s business through an agreed strategy.

What are the problems which may be faced while making a Shareholders Agreement?

While preparing a Shareholders Agreement, it is important to consider the position of the controllers of the company. Many issues arise when circumstances change .  For example, the effect of dilution on a majority shareholder’s control – in the event that further capital is required.  Failure to allow for this change in circumstance can have serious consequences on the company.

Key Reflections

A Shareholders Agreement is an important investment as it prevents disagreements between shareholders. In so doing, it enables the shareholders to focus instead on the company itself, through an agreed upon strategy. The more successful the business the greater the value of the investment into a Shareholders Agreement.

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