So exactly what is a shareholder agreement?
The standard company constitution, required to initially establish the company, is primarily controlled by the provisions of the Corporations Act 2001 (Cth). It sets out the broad provisions relating to the governance of the company. For example, voting rights at general meetings, requirements for special resolution etc. Most Pty Ltd companies purchased through accountants and lawyers have a ‘standard’ company constitution and they are seldom even looked at by the shareholder.
A shareholder agreement, on the other hand, is a private contract made between all the shareholders of a company. The shareholder agreement acts in concert with the constitution and outlines the rights and obligations of each shareholder.
A shareholder agreement is less necessary for companies where “mum & dad” are the only shareholders. But where there are arm’s length shareholders, it becomes extremely important to establish upfront, whilst everyone is friendly getting along well, what is to happen in the case of certain events. Once there is a dispute, it is too late, and you will wish you had a shareholder agreement in place.
Sale of shares
Known as pre-emptive rights, the most common event that shareholder agreement addresses is how may a shareholder sell their shares? On the surface, this seems like a straightforward issue. But who should the vendor be able to sell their shares to? Do the remaining shareholder/s have a right or obligation to buy the other shares? At what price should they able to purchase them. Can the vendor sell their shares to a stranger without the consent of others?
Dispute Resolution & Deadlock Breaker
What happens in the event of a dispute between shareholders? Litigation is very costly so having a documented dispute resolution mechanism is a good idea.
A deadlock breaker provision deals with situations where the shareholders cannot agree on some aspect of the management of the company. Use of a shotgun clause which triggers the purchase of the other shareholder’s shares at a nominated price is one example. Or a chairman clause, which nominates one shareholder to have a casting vote to resolve a deadlock. Another more dramatic option is a liquidation clause which provides that the company is wound up if the deadlock continues for a set period of time.
If you are the majority shareholder and an opportunity to sell the company at a premium presents itself, would you want a minority shareholder to be able to scuttle that deal? I have firsthand knowledge of a major transaction that fell through because a minor shareholder wanted to hold out for a higher price. A drag-along clause would have helped in this scenario because it means the majority shareholder can require the minority shareholder to join in the sale of the shares.
Conversely, where the majority shareholder is selling their shares, a tag-along option gives the minority shareholder the right to join in the transaction and sell their stake also.
Mandatory Sale Events
There are several events that may occur which you might want to force the sale of shares. For example, in the event of death, total and permanent disability, bankruptcy, or conviction of a criminal offence the remaining shareholders should have the right to trigger the sale of their shares. Would you want to end up with a surviving spouse as a shareholder? Or associated with a convicted criminal?
Governance and Financial Controls
Often overlooked, but frequently the source of irritation and eventual dispute, a shareholder agreement can and should include provisions on financial governance.
The provision should include board appointments and the responsibilities of board members.
Board responsibilities might include:
- Establishing general policies
- Setting strategic priorities and objectives
- Financial objectives and criteria
- Determining things of major or unusual nature that are not in the ordinary course of business
- Developing and adopting a budget for the year
- Reviewing and setting director remuneration
Financial controls would include a dividend policy which would establish:
- How much retained profit should be available for paying out as dividends
- The financial reporting obligations i.e., what information is reported, to whom and on what frequency
This is far from a complete list of possible inclusions and there is nothing governing the content of a shareholder agreement. But remember, the more complex the agreement, the more costly it will be to have drafted.
About the Author
David is the Founder and Managing Director of proCFO. David combines an accounting and consulting background with commercial experience both as a manager for large commercial businesses and as the owner of private and family businesses.