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Do I really need a Shareholders’ Agreement?

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Do I really need a Shareholders’ Agreement?

By , October 16, 2019
shareholders' agreement

In short, yes.

If you own your company jointly with another person, regardless of whether they are your mate, your brother or an investor, you need to have a shareholders’ agreement in place.

Why?

A shareholders’ agreement acts as a roadmap for how you want decisions of the shareholders and directors of the company to be made and, importantly, what will happen if unexpected events take place. If a shareholder or director needs to exit suddenly, whether due to a relationship breakdown, illness, death or some other external reason, a well-tailored shareholders’ agreement will guide the business owners through a step-by-step process to facilitate that exit.

A good shareholders’ agreement takes away the need to make tough and emotional decisions, as those decisions have already been made when you – the business owners – first went into business together. The agreement should cover directors’ remuneration, decision-making, dividends and raising capital, and, most importantly, set out what will happen if an event triggers a shareholder’s exit from the business.

What happens if my business doesn’t have a shareholders’ agreement?

A share in a company is an asset, and there is no legal obligation tying ownership of that share to a related person’s employment or directorship of that company. This means that, without further contractual obligations being placed on the shareholders, there is no way to force a person to transfer their tying shares.

Case study:

Mary, Bill, and Jim go to university together and then decide to go into business together and establish a company providing ICT services – ABC Pty Ltd. They want ownership to be equal, and so the company is created with 15 shares:

Mary, Bill and Jim each own five shares through their family trusts, and each of them is a director of the company. The three get along really well and they feel there is no need to enter into a shareholders’ agreement. Also, they think it is a cost they do not need at the moment, as they are only starting out and fresh out of uni.

The business does well and begins to grow. Initially, it is easy to make decisions as a group and the business goals of each owner is aligned. However, five years after commencing the business, some issues begin to arise between the business owners:

Jim has an opportunity to be involved with another IT start-up and starts to do that work on the side, meaning he has less time to spend on ABC Pty Ltd. Mary and Bill feel that Jim is contributing less time and effort to the company, and does not deserve to be paid equally to them (either in terms of director salary or dividends).

When Bill and Mary raise this issue with Jim, he disagrees and is offended, and immediately resigns as a director, but makes it clear that he wants to retain his shares.

By this time the company employs three staff members, and Mary and Bill are starting to have some disagreements about staffing issues. Bill feels that Mary has been making some staffing decisions unilaterally that should have been approved by the whole Board, which leads to a larger disagreement about who should be the managing director of the company.

Unfortunately, Mary, Bill and Jim have never sat down and documented important decisions about how the company will operate – including which director would have responsibility for which area of the business, how decisions will be made (including what decisions have to be unanimous), how directors will be paid, and what events would trigger the sale of shares.

The three go into dispute and are unable to reach an agreement about one party buying out one or more of the others due to limited financial resources. The result is that the working relationship becomes untenable, and the business is sold to a competitor for a fraction of its potential worth, and the five years of hard work invested in the business is lost.

What next?

A good shareholders’ agreement does not need to be expensive or complicated, but it does need to be tailored to your business and the individual circumstances of the business owners. It should also be reviewed periodically to ensure it is still relevant.

If your company does not have a shareholders’ agreement, the start of a new financial year is a great time to sit down with your business partners and your lawyers to put in place this important document to help ensure that any exit from the business is facilitated while preserving both personal relationships and the value of your business.

Emily Shoemark

Emily Shoemark

Adviser | Succession Plus

Emily is a Senior Associate with Snedden Hall & Gallop Lawyers in Canberra. She works with businesses to manage the legal issues that occur at every stage of their lifecycle. She focuses on achieving practical and positive outcomes whilst assisting small to medium businesses to protect themselves against legal risks. As a Succession Plus Accredited Adviser, Emily can guide you through the succession planning process and the best solution tailored for your business needs. As an experienced business lawyer, Emily can also assist you in creating the essential documentation, protections and structures that may be required to enhance your business prior to ownership transition.