What Is A Shareholder’s Agreement + Do I Need One For My Business?

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Legal Advice When It Comes To Shareholder’s Agreements?

Written by: Richard Pinkstone l Legal Team

 

A shareholder’s agreement is a binding and legally enforceable contract encompassing the business objective of the shareholders.  If you have ever wanted to put your entrepreneurial ideas into a professionally structured business plan, the first thing to consider is the legal set-up for conducting the business that will facilitate the vision, allowing growth and addressing protection from business risks.

A start-up business will require funding either from the owner or investors and must be able to satisfy any due diligence investigations into all aspects of the business, including regulatory compliance and forming secure commercial contracts.  As soon as your business has more than one owner, you will need an agreement between the business owners that depends on the structure.  If a company is set up, the agreement will be between the shareholders of the company, if a unit trust is set up the agreement will be between unit-holders of the unit trust and if the parties remain partners (in any form, such as individual traders or as a trading company) then the partnership agreement is needed.

All these agreements serve to set out the predetermined rules as to how business decisions will be made, including raising funds and how owners or investors exit.  In this article, we are focusing on a typical Shareholder’s Agreement that will follow the decision to operate the business via a corporate entity.

Business Structures

Why would the business want to set up a company?  A common business structure recommended by advisors to their clients is to establish a company either in its own capacity or as a trustee for a trust.  Companies are easily established with low costs.  The company is the owner of the business and becomes the legally responsible trading entity: it takes out finance or raises share capital, it enters into commercial contracts, it can sue or be sued and generally, the underlying owners (the shareholders) and the decision-makers (the company directors) are shielded from personal liability that they would have if they traded as individuals.

These characteristics make a company a preferred business structure.  The company will usually have multi directors and multi shareholders who will be registered upon establishment of the company.  When a company is formed, it requires a governing constitution or model rules but the owners can customise the conduct of the management and administration of the company (and effectively the business) with the certainty of a binding contract that will reflect the intentions of the owners and should address the particular circumstances of the business as each business will be different.  Often the shareholders bring in different skills and values to the business.  A shareholder’s agreement may guide the resolution of disputes and in the event of any breach of agreement, the wronged party may appeal to the Courts to enforce its terms.

Step By Step Basics of A Shareholder’s Agreement + What Is Included

Creating a shareholder’s agreement requires the parties to address vital points before committing to the business plan.

The fundamental terms to be agreed upon are:

  • Who are the shareholders that will have equity in the business?;
  • Who is appointed a director?;
  • What are the voting rights of the shareholders?;
  • How will important business decisions be approved?;
  • What restrictions apply to the sale of shares or introducing more shareholders and raising equity capital?;
  • Who will the business employ and on what terms?; and
  • How will disputes be resolved?

Forcing the shareholders to decide in advance of their commitment to how the business will be governed serves to eliminate conflicts about such governance and decision making once the business is in operation and should set up equity holders for growth and the ability to withstand change.

The shareholders, being the underlying owners and funders of the business will typically define themselves as “key” persons or key security holders who will have the right to appoint or remove a director or make important decisions by majority approval.  The key security holders are determined by the proportionate number (or type) of shares they own and that is linked to their voting power.  If the control of the voting power comes back to a deadlock, then a right to veto will be made by the nominated key person.

What About The Estate Plan?

The management of the company is decided by a board of directors who meet at regular intervals or upon notice to come together to make important decisions also by voting rights.  Usually, a resolution of board directors is passed by a majority to votes cast by a director but may require unanimous approval.  These decisions cover, ownership rights, buy/sell insurance, the business plan, buying and selling assets, borrowing and lending money, irregular transactions, bringing or defending court proceedings, approving dividends, employing staff and approving roles and remuneration.  The agreement should provide that the directors and key security holders have access to all accounts and financial performance data on a periodic basis.

The shareholders will determine how additional funding will be achieved which may include by way of share subscription for additional shares and this may specify the amount of capital that is contributed by each security holder in accordance with an agreed business plan which may be attached to the Shareholder Agreement.

The agreement should deal with the death or incapacity of a security holder.  Some agreements do not trigger a buyout and those shares will form part of the deceased estate.  Alternatively, the shareholders may take out life and permanent disability insurance funded by the company that will pay the deceased party’s estate for an agreed transfer of shares to the surviving shareholder so that they do not have to deal with the Estate.

Similarly, if a shareholder is in default the agreement may force a buyout by the no defaulting shareholders usually at the market value of the securities less a discount.  The same may apply if a shareholder resigns from their employment or consultancy role but for the full price.

Legal Issues for Key Security Holders

A major provision in a Shareholder Agreement is the manner in which a key security holder who was a minority voter wants to exit the business because they cannot live with the board’s decision.  Most agreements provide for mediation but there may be a buy-out procedure.  Agreements may also deal with preemptive rights known as “tag-along rights” giving the non-selling security holder the right to sell alongside the selling security holder and “drag-along rights” giving the selling security holder the right to force the non-selling security holders to sell usually when 100% of the shares are sold to a purchaser.

The shareholders will have common interests in growing the business for profit and one safeguard will be to prohibit themselves from competing with the business with a non-solicitation provision which will bind the parties to the Shareholder’s Agreement together with a non-compete period in the event of the party ceases to be a shareholder and requiring the party to maintain confidentiality.

Clarity on Legal Information: Shareholder’s Agreement -VS- Partnership Agreement

The difference between a Shareholder’s Agreement and a Partnership Agreement reflects the different business structure, noting that, unlike a company, partners trade in their own names and are jointly and severally liable for debts.

A shareholder fundamentally is an investor with certain rights whereas a partner’s value belongs to themselves personally.

A partnership brings together individuals for a common business objective purpose and the Partnership Agreement will cover the same terms as the Shareholder Agreement for operating the partnership business but without the same corporate complexities and not requiring the same auditing and ASIC regulatory compliance or such things as director duties.

Getting Your Legal Questions Sorted with Canny Legal

Where are you in your business journey?  Are you just starting out or are you well established?  No matter where you are in your journey, it is important to consider what is going to happen in the long run and try to plan for the “what if’s” along the way so that you are able to keep doing what you do best – running your business.

Get in touch with our team if you think you might need to revisit your agreements, or if you’re starting from scratch to make sure that they are in place before pressing go!

Canny Legal Principal Solicitor Richard Pinkstone standing centre of the picture leaning to one side with his hands intertwined together, wearing a dark grey stripped suit with a white open colored shirt

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