Shareholders’ Agreements: the “pre-nup” of companies…. Reaching agreement before the sh*t hits the fan

On starting a company with more than one shareholder, shareholders are often advised to make a Shareholders’ Agreement. 

While a Shareholders’ Agreement is by no means a legal requirement, shareholders are well advised to record their agreement at the outset of business operations in order to regulate the way business between them is conducted.

A Shareholders’ Agreement is usually formed at the beginning of a new business venture.  A Shareholders’ Agreement is a binding contractual arrangement between shareholders and governs their relationship with one another, their business relationships and arrangements.  It also sets out the shareholders’:

• rights;
• responsibilities;
• liabilities; and
• obligations.

Why do you need a Shareholders’ Agreement?
Quite often shareholders will ask whether a Shareholders’ Agreement is actually needed particularly when the business is young, relationships are good, and finances may be tight.
So, why should shareholders seriously consider entering a Shareholders’ Agreement?

• Like all relationships, the relationship between shareholders can sour over time:  at the beginning of a new business relationship, shareholders often find it difficult to foresee a scenario in which they may fall out with one another or otherwise have difficulty in making decisions.  Unfortunately, disagreements can and do occur over time and trying to agree the provisions that govern the relationship between the shareholders after relations have begun to sour can be almost impossible.  It is far easier to formalise the relationship between the shareholders at the outset rather than to risk waiting until differences of opinion become entrenched.
• Regulate management of the company:  the day-to-day operations of the company is generally left to the board of directors (and may be delegated to company management).  However, the shareholders may believe that there are certain decisions that should not be left to the discretion of the directors and instead require shareholder approval, particularly if there are directors who are not shareholders.
• Protection of minority or majority shareholders:  shareholders often seek to protect minority shareholders with the inclusion of “tag-along” rights (the right of a minority shareholder to “tag-along” with a majority shareholder if the majority shareholder sells their shareholding to a third-party).  Similarly, majority shareholders are often protected by the inclusion of “drag-along” rights which compel the minority to sell their shares to a third-party purchaser.
• Demonstrates business stability: having a Shareholders’ Agreement can demonstrate stability of a business, with the inference that the company has planned ahead in order that any dispute will be easily and swiftly dealt with.  This can be an important consideration for banks and other creditors that may be looking to invest in a company.

What should be included in a Shareholders’ Agreement?
While Shareholders’ Agreements should always reflect the unique needs of the particular company, its business operations and the shareholders, there are a range of provisions which are generally included:

1. Conditions precedent:  does anything need to occur before the Shareholders’ Agreement becomes operational?  If so, what is the final date by which the condition needs to be fulfilled?
2. Objectives of the Company:  these provisions generally attempt to limit the business activities of the Company to those areas prescribed in the Shareholders’ Agreement.
3. Transfer of shares:  Shareholders’ Agreements can stipulate the mechanism by which shareholders may transfer their shares, often stating that where one shareholder wishes to sell their shares, they effectively give the other shareholders or the company (as the case may be) a “first right of refusal” over their shares.  This can be a useful tool, particularly for small businesses that may wish for the initial shareholders to retain the shares, rather than allow external investors and unknown individuals to join the company ownership.
4. Right to appoint Director(s):  setting out whether the shareholders have a right to appoint one or more Directors to the Board.
5. Weight of votes: setting out whether votes of the Board of Directors equates to one vote per director or whether the weight of votes is proportionate to the percentage of shares held in the company (where the director is also a shareholder or where a shareholder has appointed a particular director).
6. Dividend distribution policy:  stipulating the level and manner in which dividends are to be distributed to shareholders.  Restrictions on the distribution of dividends can be included which restrict such distribution unless/until the company achieves a particular financial threshold.
7. Confidentiality obligations: creating obligations of confidence for each of the shareholders.
8. Drag-along rights:  the right of the majority to compel the minority to sell their shares to a third-party purchaser (on the same terms and conditions of sale as the majority).
9. Tag-along rights: the right of a minority shareholder to “tag-along” with a majority shareholder where the majority shareholder is selling their shares to a third-party purchaser (on the same terms and conditions of sale as the majority).
10. Dispute resolution regime:  stipulating how disputes are to be addressed by the parties, often stating at what stage there would be a referral to mediation, or who any arbitrator may be etc.
11. Restraint of trade:  provisions included in an attempt to restrain shareholders from competing with the business of the company (both during the time of their shareholding and for a specified period after that shareholder transfers their shares).
12. Termination:  a pre-existing agreement for the shareholders to sell their shares if certain events such as death, incapacity, a company takeover offer is made, or an initial public offer is made to the Company to list on the Australian Stock Exchange (ASX).

Key takeaways
Having a Shareholders’ Agreement in place at the outset can prevent disputes and will facilitate the smooth operation of companies.  No matter how well shareholders know each other, conflict is common, with disputes often arising when a shareholder wants to sell their shares, if the company is not performing as well as hoped or if the shareholders want the company to go in different directions.
The initial cost in setting-up a Shareholders’ Agreement is nothing compared to the costs of disputes and you should therefore view the cost of preparing a Shareholders’ Agreement as an investment.  An investment in the smooth-running and stability of your company.
Cross the T can assist you in preparing a Shareholders’ Agreement which is tailored to your needs.  All parties will need to be in consultation and negotiation throughout the process, and we can guide you and provide the best advice on the risks, those provisions that are required to respond to your company’s particular needs and the best way to secure each party’s rights in the agreement.