Home > Information Sheets > Creating a shareholders agreement for your company

  1. Introduction
    • Being a shareholder in a company can be highly rewarding … until something goes wrong. Whether it be a downturn in business, a dispute between shareholders, death or incapacity of a shareholder, one shareholder desiring to leave or any other number of events.
    • While shareholders argue between themselves, litigate in court or pursue actions through court; the business suffers as the shareholders take their focus away from the company business resulting in incalculable loss to the company. Additionally, the cost of such litigation to each shareholder can be substantial.
    • One of the most critical documents in protecting your shareholding in a company and the value of the company itself, is a Shareholders Agreement. Shareholder Agreements are, as the name suggests, an agreement between the shareholders of a company with respect to any numbers of matters relating to the management of the company and the relationship between each of the shareholders.
    • The provisions of a shareholder agreement should be developed based on the number of shareholders, objectives of shareholders, funding arrangements, the nature of the business or industry in which your company operates. This document will discuss some matters that you should think about prior to drafting an agreement.
    • A Shareholders Agreement should be drafted prior to commencing business. It is important that the document is reviewed regularly to ensure it is still current. Particularly, if your business expands or is in a growth stage then you might wish to update certain provisions to ensure that you have a current agreement.
    • Every Shareholder Agreement should be different – the agreement relates specifically to your company and so should reflect your unique situation. There are numerous template documents available online for shareholder agreements however we warn that these documents need to be dealt with very carefully. If you do not understand the document or haven’t properly considered all of the matters that should be in your shareholder agreement (after seeking appropriate advices) then you may be worse off than if you had no agreement at all!
    • A common misconception is that the constitution of a company will deal with all the matters considered in a shareholder agreement anyway. While the constitution does deal with some of the matters in a typical shareholder agreement, it is far more likely that the constitution won’t be detailed enough or will not deal with your particular circumstance. A constitution is a document that, for most companies, is a standard template document that is rarely drafted for your particular circumstances.
    • We have assisted start-ups and long-established businesses in setting up and renewing their Shareholder Agreements. We think it is important that the solicitor is part of the process in deciding what goes into your agreement. We see what works and what doesn’t. We have seen many variations of the same aspect (e.g. valuing a company) and so our guidance results in better advised and more appropriate agreements.
  2. Management
    • Decision making in a company is critical – particularly with respect to:
      1. Can a shareholder appoint a director to the company?
      2. What powers do the directors have in day to day operations?
      3. What decisions require majority or unanimous consent? Think:
        1. Adopting budgets;
        2. Spending outside of the budget;
        3. Staff recruitment and management;
        4. Litigation;
        5. Growth/scaling back operations;
        6. Strategy etc.
      4. Profit distributions.
      5. Funding of the company.
      6. Prohibited activities (what is a shareholder/director barred from doing)?
  1. Deadlock Provisions
    • Deadlock provisions deal with circumstances where the shareholders cannot agree on the management of the company.
    • A shareholder agreement should set out procedures to resolve deadlocks if one arises. Some procedures include:
      1. Sale clause – enables a shareholder to serve notice on another shareholder requiring the receiving shareholder to buy his/her shares at a nominated price. If the receiving shareholder chooses not to buy those shares, he/she must sell his/her shares to the initiating party at the same nominated price.
      2. Chairman clause – enables one of the shareholders to become the Chairman in the event of a deadlock and have the casting vote on the dispute.
      3. Liquidation clause – if the deadlock continues for a set period of time, all the company’s assets will be sold and the company will be wound up voluntarily. The shareholders equally share in the expenses of liquidating the business. This solution is generally a last resort where there is no alternative other than to liquidate.
      4. Voting options – this clause typically sets out the voting entitlements of each shareholder and is the foundation for the agreement.
  1. Transfer of Shares
    • If any transfer of shares by a shareholder is proposed, most shareholders typically want to retain some control over who shares can be sold to or transferred to. This avoids “undesirables” entering your business without your consent. Some examples of clauses include:
      1. Right of first refusal – provides existing shareholders the first opportunity to purchase the shares from another shareholder of the same company before the shares can be offered to parties outside the company.
      2. Right to refuse transfer – the Board will have the discretion to refuse to register a transfer of shares to prevent unwanted parties from joining the company.
      3. Board consent to transfer – a shareholder wishing to transfer his/her shares will have to obtain the consent of the Board to transfer shares or transfer shares to certain parties.
  1. Alternative Dispute Resolution
    • Before a shareholder takes a dispute to court, it is desirable (and recommended) to first attempt to engage in alternative dispute resolution methods to resolve a dispute. Such processes generally are less time and cost consuming than litigation. Alternative dispute resolution methods can include mediation, arbitration or conciliation.
    • A shareholders agreement should be drafted in a way which allows a party to seek urgent relief in court if, for example, a shareholder is doing something that will cause loss to the company.
  2. Forced Sales
    • A shareholder agreement should specify any circumstances that the parties agree will trigger a sale of a shareholders share. This might include:
      1. Death of a shareholder;
      2. Insolvency or bankruptcy of a shareholder;
      3. Fundamental breaches of a shareholder agreement;
      4. Temporary or permanent disability;
      5. Cessation of employment;
      6. Loss of professional certification (e.g. if a shareholder requires a licence to conduct the business – eg lawyer in a law firm).
  1. Share Valuation Methods
    • This clause is a very important clause – and very important to get right. Some of the issues that arise with inappropriately drafted or considered share valuation clauses include:
      1. Shareholders feeling that they haven’t received compensation for the true value of their shares;
      2. Shareholders being paid far too much (and lumbering a purchaser with a great debt causing them to struggle to pay and continue the business);
      3. Valuation methods which are impossible to perform or which result in multiple valuations (e.g. valuation by a valuer which can be appropriate for some businesses but not others).
    • Some valuation methods include:
      1. Fixed price – price agreed by the shareholders.
      2. Assets based – the value of the net assets divided by the current number of shares.
      3. Expert valuation – usually, valuation by an accountant or professional valuer.
      4. Board valuation – those directors who are not directly involved in the transaction value the shares.
      5. Books valuations – a valuation method based on the books of the company usually involving some combination of a percentage of stock on hand, income in a year and undeclared dividends.
      6. Growth based – a valuation method which involves payments calculated and paid in the years following the sale event.
  1. Suggested way forward
    • We suggest that you think about all of the above matters. When you are ready, you are welcome to make an appointment with our firm to discuss drafting an agreement and better protecting your company.
  2. Contact details
    • For more information, please contact Robert Rooney, Principal at Swanwick Murray RochePO Box 111 Rockhampton 470074 Victoria Pde Rockhampton 4700P:     +61 7 4931 1888F:     +61 7 4931 1899E:     rrooney@smrlaw.com.au
  1. Disclaimer
    • The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Before you rely on this information, you should seek specific legal advice. This sheet is not legal advice. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this newsletter is accurate at the date it is received or that it will continue to be accurate in the future.
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