In Australia, there are two main types of companies, proprietary and public companies. Proprietary companies are also known as private companies. The permitted number of shareholders your company can have will depend on its classification as either a private or public company. This article explores the shareholder limits applicable to certain companies and the implications of exceeding those limits.
Shareholder Limits for Private Companies
If you are an early-stage startup founder or small business owner in Australia, it is almost certain that you will register your business as a proprietary (aka private company). As the name suggests, a private company is one that is privately owned. Consequently, shares in the company must be offered, owned and traded privately rather than on a publicly listed stock exchange.
By law, private companies must have at least one member/shareholder with a maximum of 50 non-employee shareholders. This limits the number of external investors the company can issue shares to.
It is important to note that special "takeover rules" will apply if your private company exceeds 50 shareholders. This is regardless of whether those shareholders are employee or non-employee shareholders. Indeed, takeover rules are very complex and impose a range of regulatory procedures and requirements. Note that your company and its shareholders must comply with all regulatory requirements when completing corporate transactions.
Treatment of Employee Shareholders
Under the Corporations Act, an 'employee shareholder' is:
(a) a shareholder who is an employee of the company or of a subsidiary of the company; or
(b) a shareholder who was an employee of the company, or of a subsidiary of the company, when they became a shareholder.
It is common for startups to issue shares to employees under an Employee Share Ownership Plan (ESOP) in an effort to reward and retain strong performing employees. Employees issued shares under an ESOP are considered employee shareholders and, therefore, will not contribute to your company's number of non-employee shareholders.
Likewise, employees who hold options under an ESOP will not count as shareholders until they exercise those options and receive shares.
Advisors and the Non-Employee Shareholder Limit
An advisor may count as a non-employee shareholder if your business treats them as a contractor (rather than an employee). Ultimately, this depends on the circumstances in which your company engages the advisor.
Notably, several factors may point to the existence of an employment relationship. For example, consider whether the:
- advisor has leave entitlements (e.g. annual leave, sick/personal leave);
- company defines the worker's hours;
- company withholds tax and superannuation on behalf of the advisor;
- advisor is engaged on an ongoing basis to perform a particular role (rather than for a specific task or project).
Founders and the Non-Employee Shareholder Limit
A founder of a private company will count towards the 50 non-employee shareholder cap. This is unless they enter into an employment agreement with the company before acquiring shares in the company. In this instance, a founder would be an employee shareholder rather than a non-employee shareholder.
Shareholder Limits for Public Companies
Unlike private companies, public companies can have an unlimited number of shareholders. In addition, public companies can also raise funds from the general public (including via listed stock exchanges where they are a listed company). Consequently, they are not required to offer and trade shares privately.
Reducing the Risk of Exceeding Shareholder Limits
If your company is approaching 50 shareholders, it may be appropriate to implement a bare trust arrangement to minimise the risk of triggering the takeover rules or conversion to a public company. Your company can implement bare trust arrangements in respect of investors and employee shareholders.
Put simply, a bare trust arrangement is where a trustee holds shares on behalf of a group of investors or employees. The bare trustee is the sole legal holder of the shares on the company's register. However, the underlying holders of those shares (the investors or employees) still retain the ultimate financial benefit of the shares that the trustee holds on their behalf.
Generally, implementing a bare trust arrangement for employees who receive shares under your company's ESOP is straightforward. This is because employees are usually more comfortable for founders to act on their behalf (than investors) when it comes to exercising rights in respect of their shares. For this reason, implementing a bare trust arrangement with a group of investors is usually more complicated. Large investors typically require greater protection of their rights. They may also require the services of a professional or corporate trustee to administer the trust (rather than the company).
Key Takeaways
By law, private companies cannot have more than 50 non-employee shareholders. On the other hand, public companies can have an unlimited number of shareholders. Notably, strict rules apply to private companies with greater than 50 shareholders in total (regardless of whether those shareholders are employee or non-employee shareholders). To mitigate this risk, you should obtain legal and financial advice to determine whether it is appropriate to implement a bare trust arrangement if your private company is approaching 50 shareholders.