Why your start-up needs a shareholders agreement

If your company has more than one owner, a shareholders agreement is one of the most valuable documents you can put in place. It sets the rules between the owners while everyone still gets along, which is exactly when those rules should be written. This guide explains what it does and why it matters.

What a shareholders agreement is

A shareholders agreement is a contract between the owners of a company. It sits alongside the company's constitution and governs how the owners deal with each other, how decisions are made, and what happens when things change or go wrong.

The company's constitution and the Corporations Act 2001 (Cth) set some baseline rules, but they are general and they do not cover the specific deal between your owners. A shareholders agreement fills that gap.

Why it matters, even between friends

The owners who most need an agreement are often the ones who feel they least need it. Two friends or a couple start a business, everyone trusts everyone, and the paperwork feels unnecessary. The agreement is not for the good times. It is for the day one owner wants to leave, a founder stops pulling their weight, someone wants to sell, or the owners simply disagree on direction.

In our experience, the disputes that do the most damage to a small company are between its owners, not with outsiders. Without an agreement, there is often no clear way to resolve a deadlock or to buy out a departing owner, and the business can grind to a halt while the owners argue. An agreement written at the start, when everyone is aligned, is far cheaper than a dispute later.

What a shareholders agreement should cover

A good agreement is tailored to the business, but most cover the following ground.

• Decision-making. Which decisions the directors can make alone, and which need shareholder approval or a special majority. This stops a major decision being made over an owner's objection.
• Share transfers. What happens if an owner wants to sell, including pre-emptive rights that give the other owners first refusal, so you do not end up with an unwanted stranger as a co-owner.
• Exit and buy-out. How a departing owner is bought out and how the shares are valued. This is the clause people most wish they had when a relationship breaks down.
• Drag-along and tag-along rights. Rules that protect both majority and minority owners if the company is sold.
• Leaver provisions. What happens to the shares of a founder who leaves early, often called good leaver and bad leaver terms.
• Dividends and funding. How profits are distributed and how further funding is raised if the company needs money.
• Dispute resolution and deadlock. A clear process for resolving disputes, and a mechanism to break a deadlock between equal owners.

The clauses that earn their keep

If we had to point to the terms that matter most in practice, they are the exit and valuation provisions and the deadlock mechanism. Almost every serious owner dispute we see comes back to one of two questions. How does someone get out, and at what price? And what happens when the owners cannot agree? An agreement that answers those two questions clearly will save a great deal of money and stress.

A 50/50 split deserves particular attention. Equal ownership with no casting vote and no deadlock mechanism is a recipe for paralysis. If you are going in 50/50, the agreement has to say how a deadlock is resolved.

When to put one in place

The best time is at the start, when you set up the company and agree the share split. The second best time is now. If your company has more than one owner and no agreement, that is a gap worth closing before a disagreement forces the issue.

Frequently asked questions

Is a shareholders agreement legally required? No. It is not compulsory, but it is strongly advisable for any company with more than one owner.

What is the difference between a shareholders agreement and a constitution? The constitution is the company's public rulebook. The shareholders agreement is a private contract between the owners that deals with their specific arrangement, and it usually prevails between them where the two overlap.

We are only two friends starting out. Do we really need one? Yes. The agreement is for the day the friendship or the business hits trouble, which is exactly when you will not be able to agree on the rules.

Can we put one in place after the company has started? Yes. It is better late than never, and best done while the owners are still aligned.

Keep reading

• Business structures and start-ups
• Corporate and commercial law
• How to set up a company in Australia: step by step

This article contains general information only and is not legal advice. For advice about your situation, please contact us. Liability limited by a scheme approved under Professional Standards Legislation.