What is a Shareholders' Agreement?

It's a pretty simple question, and it has a pretty simple answer: as the name suggests, it's an agreement between shareholders in a company.

Perhaps the more important question, particularly for tech companies and start-ups, is: why should I have one?

Setting up a company is all about risk. Usually in the start-up and small business space, people talk about risks related to finance, their intellectual property and their business relationships. But what about mitigating risk at certain stages in the natural life of a company, such as when you have to make a crucial decision that your co-owner doesn't agree with, or if one of you wants to leave the company?

If you're a start-up looking for funding, having a shareholders agreement in place will also signal to investors that you've considered and handled your business affairs in advance, and improve your bargaining position.

These are the situations where a shareholders' agreement can protect you, and your company. It's a set of rules to follow when things change, grow, or go wrong.

Do I need a shareholders' agreement?

There is no requirement under Australian law that companies have a shareholders' agreement. They are treated as a private contract between parties. This means there are a number of benefits for companies, particularly small ones where the owners are also the shareholders. These include: • Protecting shareholders in a wide variety of situations • Flexibility in crafting terms to suit the company's needs • Contract remedies for breach of terms • Ability to keep the terms of the agreement confidential

Common terms that go into an agreement

There is no one-size fits all shareholders' agreement, which is part of what makes them so appealing for dynamic and innovative companies. The most important part is that the agreement is drafted clearly, to remove any ambiguity. This is where having a lawyer involved is helpful.

Having said that, there are a number of common provisions that go into a shareholders' agreement. They can roughly divided according to the life cycle of a company:

STARTING OUT

  1. Ownership of the company/recording shareholdings – who owns which shares, and are there any special rights that attach?

  2. Sharing profits/dividends - When and how will dividends be paid, if at all?

MAKING DECISIONS

  1. Control and management of the company –

    1. Who can be elected to the board of directors

    2. Right of shareholders to appoint/remove nominee directors

    3. Circumstances under which directors can be removed or held personally liable for their decisions

  2. Issuing new shares

  3. Class rights – Creating different classes of shares, enabling founding shareholders to retain greater control of the company.

  4. Transferring shares – Mechanism for the transfer of shares, and events that give a party the right to call for a transfer of shares.

LEAVING OR ENDING THE COMPANY

  1. Rights of First Refusal - Exiting shareholders are obliged to offer to sell their shares to one of the other shareholders first before placing them on the market.

  2. Non-compete clause – A shareholder who wants to leave the company can be prevented from working for a competitor. This is particularly important for those who have a few different business ventures happening at once, and when knowledge of business plans and clients lists is highly valuable.

It's hard to imagine things going wrong when starting a new company. However, having a way to navigate tricky territory from the outset is always better than trying to fix things retrospectively. It'll also be far less expensive to have a well-drafted set of rules now than to litigate if things take a turn for the worse.