Shareholders Agreements: Why are they so important?

Startup Series

10 Feb

Written By AGH Law

Shareholders Agreements: Why are they so important?

What is a shareholders agreement?

A shareholders agreement is a contract between a company and its shareholders. It sets out the rights and obligations of shareholders and governs how the company is controlled and managed by its directors and shareholders. In doing so, a shareholders agreement provides flexibility and certainty and is often a company's most important document – especially for startups.

In this Startup Series Insight, we outline the importance of having a shareholders agreement in place and some of the key terms of a shareholders agreement.

The importance of having a Shareholders Agreement

A shareholders agreement typically operates in conjunction with a company's constitution and, where there is any conflict, the shareholders agreement is usually expressed as prevailing over the constitution. A constitution is often a generic "off the shelf" document which largely reiterates what is already provided in the Corporations Act. Accordingly, a shareholders agreement enables the company and its shareholders to establish a governance framework that is tailored to the company and deals with rights and obligations beyond those set out in the constitution.

A shareholders agreement provides transparency and certainty in relation to the rights and responsibilities of the company, its shareholders and its directors, which can lead to a more efficiently and effectively managed company, reducing the potential for disputes to arise. For this reason, prospective investors will also want to know that the company has a shareholders agreement in place.

Key terms of a Shareholders Agreement

Below is a non-exhaustive list of key provisions that should be included in a shareholders agreement.

Decision making

The shareholders agreement should outline which decisions can be made by directors and those which must be approved by shareholders. Matters relating to the day to day operations of the company should typically be reserved for the board of directors. Alternatively, significant matters such as director remuneration, share issues to third parties and major acquisitions generally require shareholder approval.
The shareholders agreement should also specify which matters are required to be passed by an ordinary resolution of shareholders (more than 50% of votes cast in favour) or by a special resolution (75% or more votes cast in favour).
Similarly, the shareholders agreement should specify which matters must be approved at board level by a majority of directors or by unanimous agreement of the directors.

Resolving deadlocks

A shareholders agreement may include a mechanism for resolving deadlocks when decisions cannot be agreed upon by either the directors or shareholders. This is particularly important when a company has an equal number of shareholders and/or directors.
At board level, a fairly common method of resolving deadlocks is for the company’s chairperson to have a deciding vote.

Financing

A shareholders agreement should set out the manner in which the company can raise funds, whether that be through equity, debt or hybrid securities (such as convertible notes/loans).

Issuing new shares

Generally, board approval is simply required for a company to issue new shares. A shareholders agreement generally includes pre-emptive rights for existing shareholders, requiring any new shares to be offered to existing shareholders before they are offered to third party investors. This provides shareholders with the opportunity to maintain their percentage ownership in the company.
A shareholders agreement will often include various instances where the company can issue shares without having to comply with the pre-emptive rights.

Selling shares

Generally, a shareholder is free to sell its shares in the company to anyone (including a third party) that it agrees to sell to. A shareholders agreement will include pre-emptive rights for the sale or transfer of shares, which require the shares to be offered to existing shareholders before they are offered to third parties.
A shareholders agreement will often include various instances where the shareholder can transfer shares without having to comply with the pre-emptive rights.

New shareholders

A shareholders agreement should require any new shareholder to be bound by the terms of the shareholders agreement. To do so, the shareholders agreement will generally require the new shareholder to enter into an accession deed before it is registered as a shareholder of the company.

Drag along

In the event a majority shareholder group wishes to sell their shares to a third party buyer, a drag along clause allows the majority shareholder group to force minority shareholders to sell their shares on the same terms. This effectively allows the potential buyer to acquire 100% of the company rather than a majority interest in the company, which may be more attractive to the buyer.

Tag along

A tag along clause allows minority shareholders to tag along when a majority shareholder group is intending to sell their shares to a third party buyer. This enables minority shareholders to sell on the same terms as the majority shareholder group and prevents the minority shareholders from being excluded from realising the value of their shares.

Do you need a Shareholders Agreement? Learn more about AGH Law’s Shareholders Pack.

The AGH Startup Hub is a dedicated place for startups and entrepreneurs to access legal services in a way that works for them.

Within the AGH Startup Hub we offer a range of fixed price Document Packs to suit your startup. Each Document Pack has been carefully curated by our lawyers to give you the high quality essentials that you need, at an affordable fixed price.

We understand that you may not want or need overly complex legal documents. You also dont want to risk it by using a template document you found online. You just want quality legal essentials to protect you and your business, and to help you get back to business.

Our Shareholders Pack includes a tailored shareholders agreement, the necessary director resolutions and a 1 hour consultation with a dedicated lawyer, all for a fixed price of $2,000 (incl. GST).

Get in touch with our team to get started or learn more about our fixed price Document Packs.

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Important

The contents of this publication should not be relied upon as legal advice, but instead as commentary and general information. Specific legal advice about your circumstances should always be sought separately before taking any action based on this publication.