Does My Business Need a Shareholders Agreement?
If your business has or will have more than one Shareholder, you should put a Shareholders Agreement in place as early as possible. Without one, important issues about control, funding, disputes and exits may first need to be worked out after a problem has arisen, when the Shareholders may find it much harder to agree.
What is a Shareholders Agreement?
A Shareholders Agreement is a private contract between its parties, which commonly include the Shareholders and may also include the company. It records the rules the Shareholders have agreed will apply between them, including how they will make important decisions, fund the company, deal with changes in ownership and manage their relationship as Shareholders.
Key facts about Shareholders Agreements:
- A Shareholders Agreement is optional. Australian companies are not generally required by the Corporations Act 2001 (Cth) to have one.
- The agreement is intended to be legally binding. Its contractual effect depends on the parties, terms, formation and execution of the particular agreement.
- It records the owners’ particular commercial arrangements. These can include control, funding, Shareholder Loans, disputes, deadlock, transfers, exits and a future sale of the company.
For a more detailed explanation of the agreement and how it works, read What is a Shareholders Agreement?.
Why is it important to have a Shareholders Agreement?
When people start a business together, they usually agree on the immediate issues: who will own the shares, who will work in the business and what each person will contribute. A Shareholders Agreement deals with issues that can arise later, when the business, the owners or their circumstances have changed.
Depending on the company, the agreement can deal with who controls particular decisions, which decisions require approval from all or a set percentage of Shareholders, how future funding will be provided and what happens if one Shareholder contributes more money than another. It can also deal with new shares, Shareholder Loans, transfers, valuation, death or incapacity and the sale of the company.
Exit provisions are particularly important. A Shareholder can continue to own shares after leaving employment, resigning as a Director or stopping work in the business. A Shareholders Agreement can set out when shares must or can be sold, who can buy them, how their value will be worked out and how the purchase price will be paid.
When should you put a Shareholders Agreement in place?
The best time is usually before the company starts trading or when a second Shareholder joins. At that stage, the owners can agree on how they want the business relationship to work before a dispute, funding problem or proposed exit affects their individual interests.
An existing company with several Shareholders can also put an agreement in place. If you are already operating without one, there is value in dealing with control, funding, disputes and exits while the Shareholders are still able to agree on the rules.
A Shareholders Agreement becomes particularly important where:
- the owners have different share percentages;
- the company is owned 50/50;
- only some Shareholders work in the business;
- the owners have contributed different amounts of money;
- an investor is joining; or
- the company expects to raise further capital.
For a more detailed explanation, read Do I Need a Shareholders Agreement?.
What happens if you do not have a Shareholders Agreement?
Without a Shareholders Agreement, the company and its owners must look to the Corporations Act, the company’s Constitution and any Replaceable Rules that apply, together with other legal rights and agreements. Problems can become more difficult when the Shareholders first have to decide the rules after the problem has arisen.
For example:
- one Shareholder wants to leave and the other wants them to remain an owner;
- the Shareholders disagree about the value of a departing owner’s shares;
- the business needs more money and only one Shareholder is willing or able to provide it;
- the owners cannot agree on an important business decision; or
- one Shareholder stops working in the business but continues to own their shares.
A Shareholders Agreement can give the owners an agreed process to follow in these situations.
How Do the Constitution and Replaceable Rules Compare With a Shareholders Agreement?
Under s 134 of the Corporations Act 2001 (Cth), a company’s internal management can be governed by a Constitution, applicable Replaceable Rules, or a combination of both. Section 135 provides for the application of Replaceable Rules and allows a Constitution to modify or displace an applicable Replaceable Rule. Read ss 134–135 of the Corporations Act 2001 (Cth).
ASIC describes the Replaceable Rules as a basic set of company governance rules. They cover matters including the powers of Directors, Director and Shareholder meetings, voting, shares, dividends and some share transfers. ASIC explains how company Constitutions and Replaceable Rules operate.
The Replaceable Rules generally apply automatically where s 135 makes them applicable. A company therefore does not need to nominate them. Where a company has a Constitution, you need to read it to determine which Replaceable Rules it changes or replaces and which applicable rules continue to operate. ASIC’s guide lists the current Replaceable Rules and their Corporations Act sections.
The Constitution and Replaceable Rules provide company governance rules. A Shareholders Agreement can go further by recording the commercial arrangements between the particular owners of the business, including funding, disputes, deadlock, exits and a future sale.
Constitution or Replaceable Rules Compared With a Shareholders Agreement
A Constitution and the Replaceable Rules deal with the internal management of a company. A Shareholders Agreement can also record the commercial arrangements the particular owners have agreed will apply between them.
| Issue | Constitution or Replaceable Rules | What Shareholders may agree in a Shareholders Agreement |
|---|---|---|
| Who manages the company | The Replaceable Rules give Directors responsibility for managing the company's business under s 198A. A Constitution can change applicable internal management rules within the limits of the law. | Which major business decisions also need Shareholder approval and the voting threshold for those decisions. |
| Appointing and removing Directors | Replaceable Rules deal with appointing Directors under ss 201G and 201H and removing a Director of a proprietary company under s 203C. A Constitution may contain different applicable rules. | Rights for particular Shareholders to appoint Directors and what happens to those rights when ownership changes. |
| Board decisions | Replaceable Rules deal with Director meetings and resolutions, including ss 248A and 248G. | Decisions requiring special approval and a process for dealing with a Board deadlock. |
| Shareholder voting | Replaceable Rules address member meetings and voting, including s 250E. A Constitution can contain different applicable voting arrangements, subject to the Corporations Act. | Reserved decisions requiring an agreed percentage of Shareholder approval. |
| Issuing new shares | Section 254D gives existing Shareholders of a proprietary company a proportional first offer in the circumstances covered by that Replaceable Rule. | Future equity funding, agreed protections against dilution, investor entry and what happens if one Shareholder cannot fund their proportion. |
| Share transfers | Replaceable Rules include provisions dealing with registration of transfers and the Directors' power to refuse registration in a proprietary company. | Pre-emption rights, permitted transfers, voluntary exits, compulsory transfers, valuation and payment terms. |
| A Shareholder stops working | The person's rights depend on their separate legal roles as a Shareholder, Director, employee or service provider. | Whether stopping work triggers a share transfer, how the shares are valued and who can buy them. |
| Shareholder Loans and unequal funding | The Replaceable Rules contain no tailored commercial arrangement between Shareholders for funding the company through Shareholder Loans. | Who contributes funding, whether it is debt or equity, what happens when contributions differ and how Shareholder Loans are dealt with on exit. |
| Disputes between Shareholders | Company governance rules determine how corporate decisions are made. | An agreed dispute process, escalation steps and what happens if the owners remain unable to agree. |
| 50/50 deadlock | The applicable corporate rules determine whether a proposed resolution passes. | A specific deadlock process and, where appropriate, an agreed exit or buyout mechanism. |
| One Shareholder wants to leave | Corporate rules govern relevant aspects of shares and transfers but do not establish a complete commercial exit arrangement between business partners. | Exit triggers, who can or must buy the shares, valuation, timing and payment terms. |
| Death or incapacity | Replaceable Rules include provisions dealing with transmission following death and mental incapacity under ss 1072A and 1072D. | Whether the event triggers a sale, who buys the shares, valuation and how the purchase is funded and paid. |
| Sale of the company | The Replaceable Rules contain no negotiated tag-along and drag-along regime between Shareholders. | Tag-along and drag-along rights, sale thresholds, price and terms, and the process for completing a sale. |
Sources: Corporations Act 2001 (Cth), including ss 134, 135 and 141 ; ASIC, The replaceable rules for company governance .
What should a Shareholders Agreement cover?
A Shareholders Agreement will commonly address:
- ownership and share classes;
- voting and control;
- Board appointments and management authority;
- decisions requiring special Shareholder approval;
- future funding and Shareholder Loans;
- new shares and dilution;
- transfers and new Shareholders;
- disputes and deadlock;
- voluntary and compulsory exits;
- valuation;
- death or incapacity; and
- a future sale of the company.
These provisions need to work together. For example, a clause requiring a Shareholder to transfer their shares after a particular event also needs a workable valuation method, a buyer or transfer process and rules for payment.
The supporting guide to Shareholders Agreement clauses and what should be included explains these provisions in more detail.
How should a Shareholders Agreement deal with voting and control?
Share percentages affect voting power, but ownership percentages alone rarely answer every question about control. The agreement can identify decisions that management or the Board can make and decisions that require Shareholder approval.
Reserved matters can require a higher voting threshold for major decisions, such as taking on substantial debt, issuing new shares, changing the nature of the business or selling major assets. The appropriate threshold depends on the shareholding structure because the same percentage can produce very different results in a 50/50 company and a company with one majority Shareholder.
How should future funding and Shareholder Loans be dealt with?
The Shareholders should decide how the company can obtain additional funding and what happens when the owners contribute different amounts. Funding may come from further equity, Shareholder Loans, external finance or a combination of these sources.
A Shareholder Loan creates a debt owed by the company to the lending Shareholder. This means two people can continue to own equal shares while one has lent considerably more money to the company. The agreement should also address a funding shortfall where one Shareholder contributes less than the agreed amount and how a future issue of shares can affect existing ownership percentages.
What happens when a new Shareholder joins the company?
A new Shareholder changes the ownership relationship and can affect voting, control, funding and future exits. Before shares are issued or transferred, the existing arrangements should be reviewed to determine how the new owner will participate in those areas.
Where the Shareholders Agreement is intended to bind the incoming owner, the person will usually need to become a party through the accession or other contractual mechanism required by the agreement. The company may also need to update its corporate records and make any required ASIC notifications.
What happens when a Shareholder wants to leave?
A Shareholder can continue to own shares after resigning as a Director, leaving employment, retiring or otherwise stopping work in the business. The Shareholders Agreement can establish when a transfer occurs, who can buy the shares, how the price is calculated and when payment is due.
Different rules may be appropriate for a voluntary sale, death, incapacity, insolvency or a serious breach of the agreement. The commercial effect of an exit clause therefore depends on more than the event that triggers the transfer.
See Shareholder Exit Provisions for the detailed issues that should be considered when setting up an exit process.
What should a 50/50 Shareholders Agreement deal with?
Two owners with 50% each have equal voting power as Shareholders. Their agreement should identify which decisions either person can make, which require joint approval and what process applies when they cannot reach an agreement on an important issue.
Funding also needs careful treatment. One owner may contribute more money without receiving additional shares, or a future share issue may change the 50/50 ownership if the owners participate in different proportions. Exit and deadlock provisions also need to take account of each owner’s ability to fund a buyout.
These issues are covered in more detail in 50/50 Shareholders Agreements.
What are tag-along and drag-along rights?
Tag-along rights can allow a Shareholder to participate when another Shareholder sells their shares to a third party. Drag-along rights can require other Shareholders to participate in a qualifying sale, allowing a buyer to acquire the required level of ownership.
The agreement needs to specify when these rights apply, the ownership threshold that triggers them, the sale terms and the process Shareholders must follow. The appropriate provisions depend on the ownership structure and how the owners want a future sale to work.
See Tag-Along and Drag-Along Rights for a detailed explanation.
How does a Shareholders Agreement work with the Constitution?
A company’s Constitution and its Shareholders Agreement can deal with some of the same subjects, including voting, Directors, new shares and transfers. They should therefore be considered together when the Shareholders Agreement is prepared.
A Shareholders Agreement operates as a contract between its parties. A Constitution has statutory contractual effect under s 140 of the Corporations Act 2001 (Cth) between the company, its members, Directors and company secretary in the circumstances set out in that section. Read s 140 of the Corporations Act 2001 (Cth).
The differences are explained in Shareholders Agreement vs Constitution.
What other agreements may be required?
One person can have several legal relationships with the same business. A Shareholder may also be a Director, employee, contractor, service provider or lender, with different rights and obligations applying to each role.
The Shareholders Agreement can deal with the ownership consequences of events such as a person stopping work in the business. An Employment Agreement or Services Agreement governs the person’s work, while a Loan Agreement can record money lent to the company. Where the Shareholders are also Directors, their Director arrangements may also need to be documented.
Blaze Business & Legal can prepare a Purpose-Written Shareholders Agreement OR Combined Purpose-Written Shareholders Agreement and Directors Agreement, depending on the arrangements that need to be documented.
Can My Business Use a Template Shareholders Agreement?
A Template Shareholders Agreement can be suitable where its provisions fit the company’s ownership structure and the arrangements agreed between the Shareholders.
Before purchasing a Template, check:
- the issues the document covers;
- whether those provisions fit your business and Shareholder arrangements;
- whether the service includes legal advice or an individual Lawyer review;
- how any customisation works;
- any exclusions or limitations of liability in the provider’s Terms and Conditions; and
- any indemnities that apply to your purchase or use of the document.
How Can I Make Sure a Draft Shareholders Agreement Works for My Business?
Blaze Business & Legal provides a separate $27 Shareholders Agreement Workbook to help you work through the main ownership and commercial issues your Shareholders Agreement needs to address.
You can use the Workbook to assess a draft Shareholders Agreement from Blaze Business & Legal or another document provider by comparing the draft with your actual business and Shareholder arrangements.
Which Shareholders Agreement Option is Right for My Business?
Blaze Business & Legal provides different Shareholders Agreement services so you can choose the level of legal input and drafting that suits your ownership arrangements and budget.
Template Shareholders Agreement: $850 + GST
For simple Shareholder arrangements that fit the provisions in Blaze Business & Legal’s existing Lawyer-prepared Template.
Customised Template: $850 + GST plus agreed additional drafting
For Shareholder arrangements with some intricacies where the Blaze Business & Legal Template remains a suitable starting point. The additional drafting is quoted at a fixed price before the work is undertaken.
Purpose-Written Shareholders Agreement OR Combined Purpose-Written Shareholders Agreement and Directors Agreement: from $2,500 + GST
Rachelle drafts the agreement specifically for your business, ownership structure and Shareholder arrangements.
Where the Shareholders are also Directors and both relationships need to be documented, the service can instead include a Combined Purpose-Written Shareholders Agreement and Directors Agreement.
Why use an experienced Commercial Lawyer for a Shareholders Agreement?
A Shareholders Agreement can affect who controls the company, when owners must provide more money, whether their ownership can be diluted, when shares must be sold and how much a departing Shareholder receives. These provisions can have significant financial consequences for both the business and its owners.
An experienced Commercial Lawyer can identify the issues created by the particular ownership structure, explain the available options and draft provisions that work together. Rachelle Hare has more than 25 years’ experience across Commercial Law, private practice, General Counsel and Commercial Management roles, legal and commercial advisory work and business ownership. She has also personally negotiated and drafted the Shareholders Agreement and Directors Agreement governing a business she owns with a business partner.
If your arrangements need individual legal advice and purpose-written drafting, speak with Commercial Lawyer Rachelle Hare about your Shareholders Agreement.
How much does a Shareholders Agreement cost?
Blaze Business & Legal’s Template Shareholders Agreement costs $850 + GST. A Customised Template costs $850 + GST plus the fixed price quoted for agreed additional drafting, while a Purpose-Written Shareholders Agreement or Combined Purpose-Written Shareholders Agreement and Directors Agreement starts from $2,500 + GST.
The appropriate option depends on the ownership structure and the amount of individual drafting required. Compare Shareholders Agreement costs and the different service options.
FAQs About Shareholders Agreements
Is a Shareholders Agreement legally binding?
A properly formed and executed Shareholders Agreement is intended to operate as a binding contract between its parties. Its terms need to comply with applicable law, and the agreement should be considered together with the company’s Constitution and the Corporations Act.
Can we prepare a Shareholders Agreement after the company has started trading?
Shareholders can put an agreement in place after the company has started trading. Existing ownership, Shareholder Loans, financial contributions, working arrangements and any issues already agreed between the owners should be identified before the agreement is prepared.
Does a Shareholders Agreement replace the Constitution?
A Shareholders Agreement and Constitution have different legal functions and can operate together. Where both documents deal with the same subject, their provisions should be reviewed together to identify and address inconsistencies.
Does leaving the business mean a Shareholder has to sell their shares?
A Shareholder can continue to own shares after leaving employment, stopping work in the business or resigning as a Director. A sale or compulsory transfer requires an applicable legal or contractual mechanism, which can be established in the Shareholders Agreement.
Can a Shareholders Agreement be changed later?
The parties can amend the agreement using the amendment process set out in the document. A review is worth considering when ownership changes, a new investor joins, the company raises capital or the commercial arrangements between Shareholders change.
Speak With Rachelle About Your Shareholders Agreement
If you are starting a business with another person, adding a Shareholder or already have multiple Shareholders without an agreement, Rachelle can advise on the ownership and commercial arrangements that need to be documented and which Shareholders Agreement option suits those arrangements.
Speak with Commercial Lawyer Rachelle Hare about putting your Shareholders Agreement in place.
