What is a Shareholders Agreement and How Does It Work?

Business Structuring

What is a Shareholders Agreement and How Does It Work?

A Shareholders Agreement is a legally binding contract entered into by the shareholders of a company, which governs both their business relationships and arrangements with each other and third parties. It sets out the shareholders rights, responsibilities and obligations and regulates those issues which are not generally covered by the company’s constitution.

Although you are not legally required to have a shareholders agreement, it is strongly recommended you do as it is not uncommon for issues to arise and disputes to occur down the track. The following is a shareholders agreement checklist of items that should be included:

Day-to-Day Business Operations

The agreement will generally set out how the business is to be operated. In smaller businesses, where the shareholders are also actively involved in the daily operations of the business, it’s common to outline those roles as well. In larger companies, the Agreement is less likely to be so specific about the roles of the Management Team and it will simply outline the overall objective of the company.

The Directors

In any company, there are two key groups which make up the overall structure of the business: shareholders and directors. The shareholders are the owners of the company and are responsible for the appointment of a Board of Directors who oversee the management of the company. The Board of Directors hold a great deal of power when it comes to the Company therefore it is imperative the shareholders agreement outlines how directors will be appointed and replaced, what their duties are and the extent of their power. Without that, the Board would be given virtual carte blanche to run the company as they see fit.

Sale or Transfer Clauses

Disputes may be commonplace, but none more so than when dealing with the sale or transfer of shares in a company. Your shareholders agreement checklist should also cover the inclusion of clauses such as the “the right of first refusal”, “buy back” and “tag along” and “drag along” provisions. These help to reduce the possibility of such disputes.

>  A Right of First Refusal simply means that when one shareholder decides they want to sell their shares to a third party, the other current shareholders have the right to purchase those shares at the rate agreed to by the third party. Should the third party be willing to pay a higher price than any of the current shareholders, then the sale will generally be deemed to be acceptable.

>  A Tag Along Clause is used to protect the minority shareholder. Should the majority shareholder decide to sell their shares to a third party, the tag along clause means that the minority shareholder has the right to piggy back that deal and have their shares bought at the same rate.

>  A Drag Along Clause is used to prevent difficult minority shareholders from preventing a reasonable sale of shares by the majority. In certain circumstances, the majority will be able to force the minority shareholders to sell their shares at the same time.

Saves you Time & Money

Despite having to outlay the initial cost of a shareholders agreement, it will definitely save you money in the long run. The initial set up fees pale in comparison to the legal fees you would have to pay should legal action be required to remedy any disputes or bad deals you fall victim to.  

Symbol of Stability

Not only does it save the business time and money, a shareholders agreement also acts as a symbol of stability to third parties. This is particularly applicable when applying for business loans and credit cards.

How do I get a Shareholders Agreement without it Costing a Fortune?

If money is an issue when you’re just starting out or you simply have no desire to pay legal fees, The Lazy Lawyer has a comprehensive Shareholders Agreement template you can download which covers all the essential elements your business will need. Even if you do decide to seek legal advice, having this initial shareholders agreement example will save you time and money on legal fees as the lawyer isn’t required to draft anything.

Save yourself time and money and ensure you protect your business interests by having a comprehensive shareholders agreement from the outset.

Kate Horman

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Comments (1)
Wendy Huang

Wendy Huang, Full Time Blogger and YouTuber at A Custom Blog in 4 Minutes

Great article Kate :)