Understanding Shareholder Agreements in Australia

Every unsuccessful business is different, but every successful business has one thing in common: the shareholders get along.  

How this is achieved can vary.  From the legal perspective, we recommend and help our clients implement a shareholder agreement.

Whether you're a seasoned entrepreneur or just starting your journey, understanding the nuances of shareholder agreements can pave the way for successful collaboration and protect your (time and money) investment.

This article sets out the complexities involved in Shareholder Agreements in Australia and offers some actionable strategies to ensure your agreement reflects both your vision and legal safeguards.

Understanding Shareholder Agreements

A shareholder agreement is a legally binding contract that outlines the rights and responsibilities of the shareholders of a company.

This document serves as a blueprint for how the business will operate, detailing the key aspects of a company including decision-making processes, the distribution of profits, and the transfer of shares.  The hope is that by setting clear expectations, a shareholder agreement helps prevent conflicts and provides a structured framework for resolving disputes.

Usually, a shareholder agreement will override a company’s constitution to the extent they conflict.  This helps avoid negotiating the two documents in detail and simplifies corporate governance compliance.  

Creating a shareholder agreement can be a complex process, given the wide range of matters they cover and thee different nature of certain types of shareholders (ie founders vs investors / angels vs VCs / and so on).   However, a well-drafted agreement can provide long-term stability for the business. It is important to involve all shareholders in the drafting process to ensure that their concerns are addressed and that they fully understand their rights and obligations..

The role of a lawyer in drafting Shareholder Agreements

Finding the right lawyer to help with your Shareholder Agreement is important.  Firstly, lawyers should bring a wealth of legal expertise and experience to the table, ensuring that the agreement complies with all relevant laws and regulations.  From past experience of seeing where businesses have failed, they can identify potential legal pitfalls and provide guidance on how to avoid them.

Your lawyer can also facilitate uncomfortable conversations between shareholders.  Many provisions in the agreement are designed to govern rights if the shareholders find themselves in a dispute.  Many clients starting out are rightly not keen to dwell on such occurrence.  However, the start of a business journey is the best time to have these conversations.  This helps set expectations and if things do go wrong you will know the processes and risks in advance.

In the long run, the process of preparing the agreement is just as important as the final document.  A well-considered agreement can foster a positive corporate culture and contribute to the overall success of the business.

Key Components of a Shareholder Agreement

A comprehensive shareholder agreement should ensure that all aspects of the shareholder relationship are addressed.

Critical elements are:

·      How is the board to be constituted?  Who gets to appoint a director and why?  Will these rights remain in place in the future or fall away as shareholders are diluted?

·      What are the restrictions on transfer or issuance of shares?  Generally, existing shareholders want the opportunity to buy shares before they are offered elsewhere.

·      What matters require shareholder approval or board approval?  Give too much power to shareholders and you may find no one wants to work for your business and it becomes dysfunctional.  Give too little and shareholder may find themselves in unexpected an unfortunate circumstances.  

Common Mistakes

When drafting a shareholder agreement, it is important to avoid common mistakes that can undermine the effectiveness of the document.

One common mistake is failing to involve all shareholders in the drafting process. Each shareholder should have the opportunity to provide input and express their concerns. This ensures that the agreement reflects the interests of all parties and reduces the risk of future disputes.

Another mistake is using vague or ambiguous language.  This is a legal document and whilst it should be personalised, the language must be technically correct.  It is not a mission statement or code of conduct.  Such documents should be prepared separately and can be referenced but not included.  If there is certain information you want to include but not intend to be binding its best to set these out in the recitals (and make clear the recitals are not binding).

Failing to address potential future scenarios is another common pitfall. The agreement should include provisions for a wide range of possible situations, such as the death or incapacity of a shareholder, the sale of the company, or changes in the market environment. By anticipating these scenarios and including appropriate provisions, the agreement can provide a higher level of protection for the shareholders and the company.

Dispute Resolution Mechanisms

Dispute resolution mechanisms are a helpful component of any shareholder agreement. These mechanisms provide a structured framework for resolving conflicts and disputes that may arise between shareholders.

Usually, the process should set out a number of phases to escalate efforts to resolve a dispute prior to court action.  This may be: informal meetings, formal meetings, mediation or similar.

Including clear and detailed dispute resolution provisions in the shareholder agreement can help prevent conflicts from escalating and provide a clear path for resolving issues. These provisions should outline the steps and procedures for initiating and conducting mediation or arbitration, as well as the rules and guidelines that will govern the process. By establishing a well-defined dispute resolution framework, the agreement can help maintain positive relationships between shareholders and promote a stable and collaborative business environment.

Where to find a tempalte Shareholder Agreement 

If you are looking for an open-source agreement, many investors in Australia will prefer you start with the Australian Investment Council’s template.  This is publicly available and at the date of this article is available here: https://investmentcouncil.com.au/

Want to chat?

If you would like to discuss your Shareholder Agreement with a lawyer from Dexterity Law, please reach out to contact us here.