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The Importance of a Shareholders’ Agreement for Australian Companies

The Importance of a Shareholders’ Agreement for Australian Companies

For private companies with more than one shareholder, a crucial document that helps to steer the company as it operates or when it encounters change or disputes, is the shareholders’ agreement. While the excitement of launching a company might overshadow the need for this document, the implications of not having a shareholders’ agreement can be far-reaching and detrimental to the success and harmony of the business. In this article, we delve into the reasons why a shareholders’ agreement is an important legal document for Australian companies.

What is a shareholders’ agreement?

A shareholders’ agreement is a legally binding contract among a company’s shareholders. It outlines the rights, responsibilities, and obligations of each shareholder, helping to regulate their interactions, decision-making processes, and dispute resolution procedures. A well-drafted shareholders’ agreement serves as a powerful tool to safeguard the interests of all parties involved.

Important issues that are addressed in a shareholders’ agreement include:

  • Decision making authority
  • Issuing new shares
  • Payment of dividends
  • Sale of existing shares
  • Protection for minority shareholders
  • Exit strategies
  • Dispute resolution
  • Confidentiality and non-compete clauses

Navigating Ownership and Decision-Making

A shareholders’ agreement will outline the relationship between the shareholders and the company, and between the shareholders themselves. Without a shareholders’ agreement in place, the decision-making powers might be left to the majority shareholder(s). This can lead to confusion, disagreements, and even deadlock situations. A thoughtfully crafted agreement establishes clear guidelines for ownership percentages and delineates how crucial decisions are to be made, ensuring a smoother operational process.

Issuing New Shares & Payment of Dividends

A shareholders’ agreement will set out the process by which shares should be issued. This is an important clause as issuing of new shares affects the percentage ownership of existing shareholders, which may affect their rights.  Usually, new shares are first offered to existing shareholders.  The shareholders’ agreement also includes how the company will determine what amount dividend is payable and the method for payment.

Protecting Minority Shareholders

In many cases, not all shareholders hold equal stakes in a company. Minority shareholders, those who own less than 50% of the company, might find themselves vulnerable to decisions driven by majority shareholders. A shareholders’ agreement can provide protective measures for minority shareholders, such as requiring special approval for significant transactions or ensuring representation on the board of directors.

Exit Strategies

The future of a company might not always involve all initial shareholders. Some may want to exit the business for various reasons, including retirement or pursuing new opportunities. Without a shareholders’ agreement outlining the terms and procedures for selling shares, the departure of a shareholder can be challenging and disruptive. These agreements can specify how shares can be sold, the valuation process, and any rights of first refusal that other shareholders may have.

Managing Disputes

A key element of a shareholders’ agreement is details on the process to resolve disputes. For example, if there is a dispute on how the company is managed or how decisions are being made by the director; or if there is a dispute on whether a shareholder has committed misconduct or breached its obligations under the shareholders agreement. Having a clear written process of the steps to take in the event of dispute minimises disruption to the business.

Confidentiality and Non-Compete Clauses

A shareholders’ agreement can also include clauses that protect the company’s sensitive information and trade secrets. Additionally, it can prevent shareholders from engaging in activities that might compete with the company, ensuring that their interests remain aligned with the business’s success.

Tailoring to the Company’s Needs to Maximise Performance

One of the most significant advantages of a shareholders’ agreement is its flexibility. It can be tailored to the specific needs and goals of the company and its shareholders. This allows for customisation of terms that suit the company’s industry, size, and growth trajectory. For example, if a company’s employees are also shareholders of the company, then a vesting or leaver clause will set out the process of how the shares can be earned or sold. If the employee leaves the company, a leaver provision will detail how their shares are handled when they leave, depending on whether they are ‘good leavers’ or ‘bad leavers’.

Shareholders Agreement Case Example

Consider the case of ABC Corporation, a company founded by two friends. In the excitement of launching their innovative product, the friends neglected to draft a shareholders’ agreement. Initially, everything seemed promising, and they successfully secured funding and gained traction in the market.

However, as the company grew, differing opinions on strategic direction emerged among the two shareholders. With no clear guidelines on decision-making, these disagreements escalated, leading to a stalemate that hindered the company’s progress. The lack of a shareholders’ agreement also meant that there were no provisions for resolving disputes or mechanisms for buyouts.

The dispute eventually led to legal proceedings between the shareholders, which lasted for years and damaged the company’s reputation in the process. The absence of a shareholders’ agreement not only cost ABC Corporation financially but also strained relationships that had once been strong.

Conclusion

While many elements contribute to a company’s success, a shareholders’ agreement stands out as a critical document that shapes the course of the business journey. By providing a clear framework for ownership, decision-making, dispute resolution, and exit strategies, a shareholders’ agreement ensures that all parties involved are on the same page, reducing the risk of conflicts that could undermine the company’s growth and prosperity.

While the initial process of drafting and agreeing upon a shareholders’ agreement might require time and effort, the protection it affords and the conflicts it prevents are immeasurable. In the end, the value of a shareholders agreement extends far beyond the ink on the paper; it underpins the stability and resilience of a company in an ever-changing business landscape.

West Perth Legal regularly provides legal advice and drafting services on shareholders’ agreements and legal questions associated with shareholders and company ownership. Contact us for a complimentary 15-minute initial telephone consult.