Business

Why you need a shareholders agreement

25 May 2021

Tony Peterson

Tony Peterson is a Commercial Litigation Lawyer with Roberts Legal in Newcastle, NSW. He specialises in complex commercial disputes and has considerable experience in disputes involving business partners.

When you’re making a change to business ownership, a shareholders agreement is an important document to have in place to protect the interests of all parties. Find out more about what a shareholders agreement might include and why your business might need one.

The current landscape for financial planners is a difficult one, with increased regulation and enforcement activity and increased fees for licences. This has understandably caused some financial planners to review their current structure and consider whether two or more businesses can be merged or consolidated under one licence to keep costs down. Alternatively, financial planners may be considering adding new partners to their business to increase revenue.

Consolidating or merging under one licence can be achieved through various transactions, including a merger or acquisition of a business or businesses, or the issue of shares to a new shareholder. In each of these transactions, financial planners will face new business, and/or shareholder relationships.

It is important to consider these new relationships and make sure each party understands their obligations and rights to avoid future disputes. A document governing the relationship between shareholders is a shareholders agreement and this is critically important to the smooth functioning of a new or changed company entity.

What is a shareholders agreement and why do I need one?

A shareholders agreement is a contract between two or more co-owners of a company setting out their agreements with respect to management and control of the business and roles and responsibilities of each of the co-owners. Unlike a Constitution of a Company, a shareholders agreement does not have to be made public, which allows for parties to include sensitive company matters.

The shareholders agreement is a legal document and can be relied on in any dispute between shareholders and will often be the first port of call in a dispute. Without a shareholders agreement, the company would be controlled solely and exclusively by laws which can be insufficient to prevent, and assist with, resolution of disputes.

Simply going through the process of preparing a shareholders agreement can often allow issues to be raised and dealt with at the outset, rather than delaying these conversations until a time when tensions are higher and consequences are greater.

We are commonly involved in disputes between shareholders or partners.  When there is no written agreement, the process or resolving any dispute is generally much more difficult and, more expensive as a result. As with insurance – you often don’t need a shareholders agreement until something goes wrong. But if a problem should arise, you will be glad you have a written agreement.

A partnership agreement is similar to a shareholders agreement in that it sets out the way that a partnership will operate. This article will focus on shareholders agreements, however many of the principles are also relevant to partnership agreements.

What should a shareholders agreement cover?

A shareholders agreement can (within reason) cover any topic that the parties would like to include.  However, there are certain clauses that should be included and topics that should be covered.

  • Management

Ordinarily, shareholders of a company will appoint directors to manage the business of a company. A shareholders agreement can deal with the process of appointing and removing directors, and how and when the board of directors should meet.

The shareholders of a company may wish to limit the powers of some shareholders and reserve certain rights for founding shareholders or shareholders with a certain class of share. For example:

  • Are all shareholders entitled to the right to appoint directors or is ownership of a certain percentage of shares required?
  • Are votes of directors linked to ownership of shares?

A shareholders agreement can also set out what decisions are to be made by the board of directors and those to be made by the shareholders. It can also set out the way decisions of shareholders are made (for example by a vote of 50% of shareholders or 75% of shareholders). The agreement should also deal with what will happen in the case of a deadlock.

  • Share allocation and types of shares

The shareholders may want to have different classes of shares carrying different voting rights and dividend entitlement.

  • New shareholders/capital raising

The agreement can cover how shareholders contribute to the company and what they do/have done in exchange for their shares. Shares may also have vesting criteria such that shares are allocated upon the occurrence of a certain event or meeting certain targets or goals.

The shareholders agreement should deal with the process for issuing shares, admitting new shareholders and causing new shareholders to be bound by the shareholders agreement.

It may also be desirable to have an automatic procedure for capital injections in circumstances where the company is not performing well financially.

  • Exit Plan

How the shareholders can deal with their shares is a matter of great importance in closely held companies. For example, shareholders will likely wish to have some say in who they will be in business with and, as such, some restrictions on the right of shareholders to sell their shares is often required.

Common clauses to deal with the sale of shares included pre-emptive rights (a right to buy before they are offered to third parties), drag along clauses (a majority shareholder can force a minority shareholder to sell their shares) and tag along clauses (giving a shareholder the right to join in any sale of shares by another shareholder).

If shares are to be sold to the other shareholders, how will they be valued? Some common options include the use of a valuation formula or the appointment of a valuer to ascribe a value to the shares. Each option has pros and cons. However, when using a formula, take great care in ensuring it is appropriate for the business. Using a boiler plate valuation formula could have serious consequences if it is not appropriate for the business being conducted.

Business succession planning is also very important for a business and having provision for dealing with the death or insolvency of a shareholder in a shareholders agreement is one option in planning for these events. For example, shareholders may not want a deceased estate, bankrupt estate or spouse of a shareholder (if gifted the shares via a will) to exercise control over the company.

  • New business opportunities

Shareholders may want to include a term requiring shareholders to bring new business opportunities to the company in the first instance. If this is the case, there will need to be careful consideration of what types of business opportunity should be brought to the company and whether it will apply to all shareholders. Where the shareholders are all employees of the company, such an obligation could be dealt with in an employment agreement also.

  • Restraints

Where shareholders are also key employees of the business, it may be necessary to incorporate a restraint of trade in the shareholders agreement. The length and nature of any restraint is often a matter of negotiation and will be informed by legal considerations including the enforceability of any proposed restraint.

  • Disputes

The shareholders may wish to incorporate a dispute resolution procedure in the agreement.  Such clauses can include an obligation to mediate prior to commencing proceedings and/or a clause requiring private arbitration or expert determination rather than public litigation.

  • Review date

One of the most important aspects of a shareholders agreement is often overlooked – setting review dates and undertaking reviews. Businesses can change over time in how they operate, who their key employees and clients are and how profitable they are. If the nature of a business changes over time, this can affect how suitable some clauses in a shareholders agreement are. By way of example, a valuation method in a shareholders agreement may no longer be appropriate if the company becomes more or less profitable.

Any smart company will have a comprehensively prepared and considered shareholders agreement, which will ultimately:

  • Allow for the smooth functioning of the company,
  • Pre-determine how shareholders and the company deal with certain matters, such as for the sale or exit of a shareholder, to limit sometimes nasty, costly and stressful disputes,
  • Address the obligations and rights of the shareholders, and
  • Save the shareholders and the company legal costs, time and stress in circumstances where a dispute arises between the shareholders.

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Tony Peterson is a Commercial Litigation Lawyer with Roberts Legal in Newcastle, NSW.  He specialises in complex commercial disputes and has considerable experience in disputes involving business partners.