What is a shareholders agreement?
A shareholders agreement (SHA) is a contract between the shareholders of a company. A SHA includes:
- rights and obligations of the shareholders;
- management of shares (e.g., valuation and share transfers); and
- mechanisms to exit the company.
A SHA usually operates alongside the company’s constitution.
What is the difference between a SHA and a constitution?
A constitution deals with day-to-day corporate mechanics and formal governance such as:
- the appointment, powers, and removal of directors;
- organisation and calling of both directors’ meetings and shareholder meetings;
- issuing shares; and
- dispute resolution.
Whereas, the purpose of a SHA is to protect each shareholders’ interest, establish their rights and obligations to the company, and provide clear exit pathways (i.e., share sales or transfers). It focuses on the practical implications and scenarios that arise when there are multiple interests vested in the company.
Why is a SHA important?
A SHA is a critical risk management tool to balance the inherent competing interests, different levels of involvement (or investment), and varying expectations of multiple shareholders. Aligning all interests upfront, via a clear set of rules, reduces the risk of disputes as the company grows and changes.
A SHA provides certainty around ownership and exit. Mechanisms such as pre-emptive rights, drag-along and tag-along provisions, and compulsory transfer events ensure that ownership transitions are controlled and do not destabilise the business.
In practice, structured pathways are crucial to mitigate disagreements, reduce disruptions to operations, and maintaining discipline to shareholder relationships – ultimately protecting the stability and value of the company.
50/50 Ownership – does it work?
Many founders assume that equal ownership is the fairest approach. However, 50/50 ownership structures can create significant governance challenges, commonly known as a deadlock.
Deadlock occurs when shareholders with equal voting power cannot agree on fundamental business decisions. Without a way to resolve these disputes, the company can become paralysed, delaying important decisions, disrupting operations and straining commercial relationships. In some cases, resolving the issue requires costly litigation.
Structuring ownership so it is not exactly 50/50 can reduce the risk of stalemates by giving one shareholder a practical majority. Agreeing on these processes and ownership structures in advance ensures disputes can be resolved efficiently, as negotiating solutions becomes far more difficult once a deadlock has already arisen.
Alternatively, provisions can be included in a SHA to help manage potential deadlocks, such as tie-breaking votes, buy-sell mechanisms or mediation and expert determination.
What happens if you don’t have a SHA?
Without a SHA, disputes between shareholders default to the rules contained in the Corporations Act 2001 (Cth). These statutory regulations are broad and are not designed to address the nuanced relationships and existing agreements between shareholders and the company. As a result, they may not have the practical mechanisms required to manage a dispute before significant damage has already occurred.
How Morgan + English supports you
Whether you are founders starting your first venture, or experienced business owners establishing a new company, putting a comprehensive shareholders agreement in place early is a crucial step.
If you need assistance on preparing or reviewing a shareholders agreement, contact Lisa: lisa@morganenglish.com.au
