In Short
- A shareholders' agreement sets out rights, obligations, and decision-making processes tailored to your startup.
- It covers governance, issuing and transferring shares, shareholder protections, and founder/employee retention.
- While not legally required in Australia, it is strongly recommended to avoid disputes and protect all stakeholders.
Tips for Businesses
When drafting a shareholders' agreement, focus on practical issues: who controls decisions, how shares can be issued or transferred, and protections for both majority and minority shareholders. Including clauses on vesting, leaver events, and dispute resolution will help safeguard your company's stability and growth.
When launching a startup, excitement often centres on the product, customers, and growth. But one of the most critical documents for protecting founders and investors alike is often overlooked: the shareholders' agreement. This article will break down the essential clauses of a comprehensive shareholders' agreement, explaining what they mean in plain English. By understanding these key provisions, founders will be better equipped to instruct their lawyer and ensure the agreement truly safeguards their company's future.
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In Australia, a company is not legally required to have a shareholders' agreement. However, it is recommended that companies with more than one shareholder establish a shareholders' agreement to set out the shareholders' rights, obligations and decision-making processes in a way that is tailored to that startup.
Board of Directors
The shareholders' agreement should specify the maximum number of directors, typically an odd number like 3, 5, or 7, to prevent deadlocks, while allowing for future growth. It will outline who can appoint directors, which usually includes the founders (so long as they remain shareholders), shareholders with a certain percentage of shares (e.g., 20% or more), and the board itself. The agreement should also address director removal, particularly for shareholder-appointed directors.
Generally, shareholders with appointment rights prefer exclusive removal rights for their appointees. These provisions ensure clear governance structures and protect various stakeholders' interests in the company's leadership.
Meetings
The number of annual board meetings and the required quorum will also be specified. Typically, founders who have appointed themselves as directors will require the quorum to include all founders to be present for it to be satisfied. This means that any decisions made at a board level must include the founders being present.
Shareholder meetings might also have a similar structure, whereby founder shareholders require that they are present for any quorum to be satisfied.
Decision-making Process
Most importantly, the shareholders' agreement sets out how decisions are made in the company, either at a board level or shareholder level. In most companies, the day-to-day decisions are made by a simple majority of directors (i.e., 50%). This approach allows for simple decisions to be made quickly and smoothly. An example might be whether the company should lease a printer. Critical business decisions are made by a special majority of the directors, requiring a higher threshold (i.e. 75% or more). These decisions might include:
- large capital expenditures;
- taking out a loan; or
- taking out significant insurance policies.
These decisions can be tailored to suit your specific start-up and can also include the veto rights of certain directors (i.e. founder directors).
The decisions requiring a special resolution (75% or more) of the shareholders are mandated mainly by the Corporations Act, which includes varying the rights of shares or winding up the Company.
Issuing and Selling Shares
Issuing new shares typically requires the approval of the
directors to facilitate any capital raising. Shareholders usually
can exercise their preemptive rights and purchase a proportion of
the shares to prevent dilution.
While director decisions are standard for share issuance, some
companies opt for shareholder approval, which, for example, may
require the approval of a key investor.
Preemptive rights also apply to shareholders who wish to sell any of their shares. The selling shareholder must first offer their shares to the other existing shareholders on a pro-rata allocation basis before any remaining shares can be sold to a third party.
Employee Incentive Scheme (ESOP)
If you intend to incentivise your employees by issuing equity (shares or options), the shareholders' agreement will set out the percentage (usually 10-20%) of equity that can be issued without shareholder approval.
Restrictions on Share Transfers
Restrictions on share transfers (different from issuing shares) can include time-based limitations (i.e. a shareholder cannot transfer their shares in the first 12 months) or board approval requirements. Permitted transfers to affiliated entities or family trusts are shared for tax purposes.
A standard "first right of refusal" clause typically allows existing shareholders to purchase shares before third-party sales, protecting their interests and controlling the entry of any new shareholders.
Drag and Tag
A drag-along right allows majority shareholders (typically 75%+) to force minority shareholders to join in selling their shares to facilitate a whole company acquisition. Conversely, tag-along rights protect minority shareholders by allowing them to 'tag' along or join a major stake sale (typically 75%+) to a third party. Both rights are standard, and the thresholds usually match.
Events of Default
The event of default clause exists to penalise shareholders from taking specific actions that could harm the company. Examples of an event of default might be if a shareholder starts a competing business, they dispose of their shares without the Company's approval, or commit a serious act, like fraud. A Company might include death or permanent incapacity as an event of default to avoid a situation where the shareholders' family or estate become the new holder of the shares.
A market standard approach to events of default typically require shareholders to offer their shares for sale (either back to the Company, another shareholder or a nominated third party). The sale price is usually fair market value, but may be discounted (usually 20-50%) if the shareholder is at fault.
Share Vesting
Vesting provisions are recommended for founders and key employees critical to the company's success. These provisions typically:
- apply to 100% of shares for new companies;
- follow a 4-year schedule with a 1-year cliff;
- allow the company to buy back unvested shares at a nominal price ($1 per share) if the founder leaves; and
- may include accelerated vesting for 'Good Leaver' events.
This structure incentivises long-term commitment, protects against dilution, and ensures share ownership aligns with value contribution to the company.
Leaver Provisions
Leaver provisions apply to employee shareholders/founders, requiring share sale upon employment cessation. Types of leavers include:
- Good Leavers (e.g., redundancy, retirement) typically sell at market value; and
- Bad Leavers (e.g., resignation within 1-2 years, termination for cause) often sell at a discount (commonly 20%).
Shares are usually offered first to other shareholders, then the company, and finally to nominated third parties.
Key Takeaways
A comprehensive shareholders' agreement is crucial for startups and growing companies. Here are five takeaway items for you to consider:
- Purpose: Establish rights, obligations, and processes tailored to the company's needs.
- Governance: Specifies board composition, director appointments, and decision-making thresholds.
- Share Issues and Transfers: Outlines procedures for issuing and transferring shares, and various restrictions.
- Shareholder Protection: Includes drag-along, tag-along rights, and default clauses.
- Employer and Founder Retention: Incorporates vesting provisions and leave clauses for key personnel.
If you have any questions about drafting a comprehensive startup shareholders' agreement, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Is a shareholders' agreement legally required in Australia?
No, it's not a legal requirement. However, it's strongly recommended for startups with more than one shareholder, as it helps clarify rights, responsibilities, and decision-making processes.
Can a shareholders' agreement be changed later?
Yes. A shareholders' agreement can be amended if all (or the required majority of) shareholders agree in writing to the changes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
