Starting a company with a friend, relative or business partner usually begins with goodwill and a handshake. Everyone is busy building the business, so the paperwork about who owns what gets pushed aside. That is understandable. It can also become expensive later if the owners fall out or one of them wants to leave.
A shareholders agreement is the document that sets out how the owners of a private company will deal with each other. It sits alongside the company’s own rules and covers the questions those rules often leave open. This article explains how the two fit together and what an agreement usually deals with. It is general information for Australian companies.
How a company is governed in Australia
Every Australian company needs a set of internal rules. According to the ASIC guidance on company rules and constitutions, a company must be governed by a constitution, the replaceable rules or a mix of both. The replaceable rules are set out in the Corporations Act 2001. They are the default position for proprietary companies.
The replaceable rules cover matters such as company officers, access to company books, meetings of directors and shareholders and shares and dividends. A company can adopt all of them, some of them or none of them. Where a constitution is silent on a topic, the replaceable rule on that topic applies. There is one exception worth knowing. ASIC notes that the replaceable rules do not apply to a proprietary company whose sole director is also its sole shareholder.
The constitution is a contract
ASIC describes a constitution as a contract between the company and its members, directors and secretary. It is also a contract between the shareholders themselves. That sounds like it might do the whole job. In practice a constitution is a fairly public, general document that applies the same way to every member.
What a shareholders agreement adds
A shareholders agreement is a private contract signed by the shareholders and often by the company too. It deals with the commercial deal between the owners rather than the formal machinery of the company. It is usually kept between the parties. Because it is private, the owners can record details they would not want in a constitution.
Think of it as the rule book for the relationship. The constitution tells you how meetings are called and how directors are appointed. The agreement tells you what happens when one owner stops pulling their weight or wants to sell out. Those are the moments that cause the most trouble in small companies.
Matters an agreement commonly covers
Every agreement is different, and the right content depends on the business and the people involved. Even so, most agreements for small private companies come back to a similar group of topics. The list below gives a sense of them. It is a starting point for a conversation with a lawyer, not a checklist to fill in alone.
- Who sits on the board and how each owner can appoint or remove a director
- Decisions that need agreement from all or most shareholders, such as borrowing or selling the business
- How much money each owner must put in and what happens if more funding is needed
- How shares are valued and offered when an owner wants to sell
- What happens on the death, incapacity or bankruptcy of a shareholder
- Restraints on competing with the business and protection of confidential information
- How disputes are raised and resolved before anyone goes to court
Selling shares and leaving the company
Exit rules are often the most valuable part of an agreement. ASIC’s summary of the replaceable rules shows that directors of a proprietary company can refuse to register a share transfer for any reason. That protects the remaining owners from an unknown buyer. It can also leave a departing owner stuck with shares they cannot sell.
The replaceable rules also include a rule for proprietary companies about offering new shares to existing shareholders first. A shareholders agreement can go further and set out how existing shares are offered to the other owners. It can fix a valuation method and a timetable. Clear exit terms tend to reduce arguments because everyone agreed on the process before there was anything to argue about.
Family circumstances can affect a company too. If a shareholder separates from a partner, their shares may form part of a property settlement. Owners going through that kind of change are usually wise to get family law advice as well as commercial advice. The agreement may need to be checked against any orders that are made.
Shares held through a trust
Many small business owners hold their shares through a family trust rather than in their own name. In that case the trustee is the shareholder and the person who signs the agreement. The trustee’s position matters when shares are sold or transferred. If you are weighing up an individual trustee or corporate trustee, it is worth thinking about how that choice sits with your shareholders agreement.
Owners who also work in the business
In small companies the shareholders are often also the staff. One owner might run sales while another manages operations. A shareholders agreement can set out each owner’s role, but their pay and conditions as workers are a separate matter. Workplace laws still apply, so it helps to understand the difference between being an owner and being an employee.
If the company pays an owner a wage, it may have the same obligations it has for any other worker. Our guide to super obligations as an employer explains that side in more detail. Where an owner’s role and their employment overlap, disputes can become tangled. In that situation advice from an employment lawyer can help separate the two issues.
Changing the rules later
Businesses grow and owners change, so the rules may need updating. ASIC explains that a company can adopt, change or repeal a constitution by special resolution. That requires at least 75% support from members voting at the meeting. Public companies must notify ASIC of the resolution within 14 days.
A shareholders agreement is changed according to its own terms. Many agreements say that changes must be in writing and signed by every party. It makes sense to review the agreement whenever a new shareholder joins or the business changes direction. An agreement that no longer matches the business can create more confusion than having none at all. You can read more in ASIC’s page on adopting or changing a company constitution.
Frequently asked questions
Is a shareholders agreement required by law?
No law requires a private company to have one. The company must still be governed by a constitution, the replaceable rules or a mix of both. An agreement is an extra layer that the owners choose to add.
Does a shareholders agreement replace the constitution?
It does not replace it. The two documents work together and should be drafted so they do not conflict. If they clash, the result can be uncertain and a lawyer should look at both.
Do sole owners need a shareholders agreement?
A company with one shareholder has nobody to agree with, so an agreement is rarely needed. The question changes once a second owner or investor comes on board. That is a good time to put one in place.
Do the rules differ between states?
Company law is mainly federal under the Corporations Act 2001, so the core rules apply across Australia. Contract law, courts and some related areas can still differ between states and territories. Laws also change, so check the current position before relying on it.
This article is general information only and is not legal advice. Laws and processes differ between states and territories and change over time. Please speak with a qualified lawyer about your own situation.
