In brief - Well-drafted shareholders' agreements help to manage disputes
The discipline to implement a shareholders' agreement can be important for new companies to align shareholders' objectives and expectations with the business plan and to confirm short-, medium- and long-term business goals.
Investors and shareholders may have different investment goals
Founding shareholders often imagine their business to be a long-term investment and want to manage for long-term growth. Third-party investors may share the founders’ optimism in the company’s future, but are interested in shorter-term profits, dividends and an ability to sell their shares (at profit).
Other investors may seek to use their investment to influence the company’s business plans as a primary objective. Friends and family may become shareholders to support the participants and expect a passive role sharing in any success of the business.
The basics around company ownership and management
A company is owned by its shareholders.
If there is only one class of shares, each share has the same rights and obligations. If the company has created different classes of shares, the rights and obligations of each class of shares will be different from the other classes.
Shareholders may manage a company directly. However, shareholders often elect to delegate some of their rights to manage a company to directors.
Directors are elected by shareholders. A director may or may not be a shareholder.
Directors, in turn, may manage a company themselves, or may appoint an executive to manage the company. The executive may be authorised to hire a team to operate the company. The lead of the executive team usually reports to the board of directors.
What is a shareholders' agreement? And does your company need one?
The Corporations Act 2001
regulates all Australian companies. The Act defines the rights and obligations of shareholders, company directors and managers, and requires a basic structure to allow shareholders to manage the company without further agreement. Many companies regulate their governance using only the provisions of this Act.
However, where a company’s shareholders want greater certainty as to the implementation of a certain business plan, as well as management of desired short- and long-term objectives, a shareholders' agreement can be useful to provide all shareholders comfort as to the company’s direction.
A shareholders' agreement sets out the company's purpose. It confirms the roles and responsibilities of its shareholders, directors and executives and can be an important tool for successful company management.
Items that might be included in a shareholders' agreement
Shareholders' agreements vary from company to company. There is no "one size fits all". Common items to include in shareholders' agreements include:
1. Management rights and the company purpose
Shareholders' agreements set out the management of the company, who is going to manage it and what rights they have. It is particularly important to set out the purpose of the company right from the start to focus the minds of the early stage investors. It is important to:
- clearly define the company’s business
- address the company’s business plan and steps the company must take to achieve its goals
- address the process for reviewing the company's progress against the business plan to allow regular review and evolution of goals
In Australia, a company must have at least one, but may have as many directors as shareholders agree.
A shareholders' agreement can set qualifications of directors and their term, who elects them and how they can be removed.
3. Timing of board meetings
A shareholders' agreement can set how often a board of directors must meet, who has the right to set the agenda and add agenda items, quorums, and whether there is a chairperson.
4. Majority and super majority voting requirements
Shareholders' agreements can determine which decisions are reserved for shareholders and which are delegated to directors. Major decisions, such as sale of the company, change of business plan and starting litigation, may need approval by both directors and shareholders.
Shareholders' agreements can also define how votes are taken. For instance, is a vote approved on a simple majority or should some decisions be a super majority or even unanimous?
Common majority voting issues include:
- adoption or material revision of the business plan and annual budget
- raising debt or issuance of guarantees
- acquisition, investment or capital expenditure above a certain amount
- IPO, merger or similar
- joint ventures
- asset acquisition or disposal above a certain amount
- accounting policies
- director remuneration
- appointment of CEO and other senior management roles
Super majority votes are for decisions either requiring unanimous or super majority directors' votes as they concern fundamental issues, such as:
- change of business, company name or capital structure
- variation of rights attached to shares
- classes of securities
- change to board of directors
- changes to constitution
5. Changes to shareholders and shareholdings
Defining the process around changing shareholders and shareholdings is important to include as it allows decisions to be made in a rational manner in times of stress or panic. It should set out the process on how and when shares can be transferred and to whom.
6. Dispute resolution
Success in the market often requires decisions being executed quickly.
Deadlock at board or shareholder level needs to be resolved before the company suffers. Deadlock provisions, such as referral to a committee, mediation, or alternating decision-making, should be included.
7. Tag-along and drag-along rights
A tag-along right assures all shareholders that if a majority (or a particular shareholder or group) of shareholders sells their stake, minority holders have the right to join the deal and sell their stake at the same terms and conditions as would apply to the selling shareholder.
Drag-along rights are a related right that enables a majority shareholder to force all shareholders to join in the sale of shares to allow a buyer to buy all outstanding shares.
This article is based on a presentation given by the author at the Advising Start-Ups Legalwise seminar held in Sydney on 25 November 2015.
This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2020.