In 2024, businesses are looking at ways to start or continue their operations while having a stronger focus on managing risks.
Often, an overlooked way of managing ongoing and future legal risk in business is by preparing a shareholders’ agreement. These agreements have several benefits including safeguarding the interests of owners, mitigating conflicts, and the provision of peace-of-mind to shareholders.
What is the difference between a Shareholders Agreement and a Constitution?
A shareholders’ agreement can provide clarity, stability, and a well-defined framework for the legal relationships among a company’s shareholders.
Distinguishing a shareholder agreement from a company constitution is important. While both govern the internal workings of a company, a shareholders’ agreement is a private, contractual arrangement between shareholders, focusing on their rights and obligations and tailored for them. In contrast, a company constitution is usually a more generic document outlining the company's structure and management. A constitution may be required to be filed with regulatory authorities, whilst a shareholders’ agreement remains confidential among the involved parties. A constitution sets the company’s broad framework, where a shareholders’ agreement delves deeper into the specifics of shareholder relationships, offering more flexibility and customisation to meet the unique needs of the stakeholders.
Defining roles and responsibilities?
Shareholder agreements go beyond establishing a contractual relationship, they craft a detailed roadmap that delineates the roles and responsibilities of each stakeholder. This clarity minimises conflicts and fosters an environment where each shareholder understands their unique contributions.
Consider what decisions can be made at director and shareholder level. For many small to medium-sized companies, the shareholders may be the same as the directors (not always the case). The shareholders’ agreement can be used to define what authority directors have, such as powers to adopting or varying a business plan, acquiring, or divesting business assets or entering into commercial agreements. A shareholders’ agreement may allow this kind of decision-making or limit it.
By outlining the scope of authority, this forms the foundation for effective decision-making and collaboration.
Streamlining the decision-making process
Defining clear decision-making roles is essential for a successful business. Shareholder agreements are crucial in ensuring efficient decision-making by establishing transparent processes and preventing ambiguity and gridlock.
Clearly defined voting procedures and thresholds in shareholder agreements streamline decision-making for asset acquisition or disposal. For example, directors can authorise the purchase of assets up to the value of $50,000 without shareholder approval, but higher-value acquisitions require shareholder approval, possibly with a special majority. Clarity reduces legal risk and aligns strategic choices with company objectives.
Drag along and tag along rights
Shareholder agreements play a crucial role in scenarios where influential majority shareholders dominate. They safeguard minority shareholders through mechanisms like tag-along rights and anti-dilution clauses, which promote equity and inclusivity. Conversely, while ensuring the protection of minority interests is paramount, shareholder agreements often incorporate drag-along rights as a pragmatic measure. This provision empowers majority shareholders to compel minority shareholders to join in the sale of the company, promoting unity in potential exit scenarios and maximising value for all stakeholders. This mechanism strikes a delicate balance between safeguarding minority rights and promoting cohesive decision-making in strategic company transactions.
Dispute resolution
Even with the best of intentions, given the unpredictable landscape of business, disputes are not uncommon. Shareholder agreements are designed to turn potential conflicts into opportunities for resolution. In a scenario where two (or more) shareholders are in dispute, a shareholder agreement may set out dispute resolution processes. These may include engaging in a mediator or facilitator and provide impartial opinion on the issue that is binding on the parties.
Alternatively, if the dispute can’t be solved or there are irreconcilable differences, there may be a process outlining the exit of one or more shareholders, or even a trigger to wind up or sell the business.
Through the inclusion of arbitration or mediation clauses, these agreements pave the way for efficient and amicable conflict resolution, ensuring minimal disruption to business operations, including avoiding costly and protracted litigation.
Confidentiality clauses
Shareholder agreements contribute to a company's resilience by incorporating confidentiality clauses. These provisions safeguard proprietary information and prevent shareholders from engaging in activities that could compromise the company's competitive advantage. The inclusion of these clauses enhances the overall security and stability of the business.
Restraints and non-compete clauses
Restraint clauses offer essential benefits for business stability and protection. These clauses seek to ensure that departing shareholders don't engage in activities detrimental to the company's interests.
Non-solicitation clauses restrict the departing shareholder from soliciting clients, employees, or suppliers of the company, preserving key relationships. These provisions foster a secure environment for investors by mitigating the risk of internal competition and protecting proprietary information.
One scenario where this may be important is where a key employee is allowed to buy equity in the company with a view to one day buy out the (original) business owners. That new shareholder may wish to protect the goodwill and relationships once they are able to complete the share buy-out.
Another scenario may be in circumstances where a shareholder wishes to depart the company (perhaps because of a dispute) and it would be important for the remaining shareholders to protect their business from possible competition from that departing shareholder.
Overall, restraint clauses enhance corporate governance, promote long-term sustainability, and provide a legal framework that encourages trust and collaboration among shareholders.
Strategic succession planning
Beyond day-to-day operations, shareholder agreements extend their influence into long-term strategic planning, particularly in succession scenarios. These agreements include provisions that ensure a seamless transition of ownership and control, mitigating risks associated with leadership changes.
Consider the decisions to succeed the managing director of the company in circumstances where they may retire or unexpectedly depart. Similarly, an active shareholder in the business may wish to allow children (or a specific child) to succeed them in the business.
By incorporating foresight into succession planning, shareholder agreements contribute to business continuity and sustained growth.
Addressing death or permanent disability
Following on from the above, a critical aspect often overlooked is the potential impact of the death or permanent disability of a shareholder. This scenario is one that often arises unexpectedly and, once it does, if there are no provisions to deal with it, it may already be too late.
Well-crafted shareholder agreements anticipate such scenarios, outlining clear procedures for the transfer of shares, valuation methodologies, and the protection of the deceased or disabled shareholder's interests.
These provisions provide stability during tumultuous times, ensuring a smooth transition of ownership while safeguarding the financial well-being of the affected party's heirs or beneficiaries.
Building trust and elevating investor confidence
Investors seek stability and assurance in their investments. A well-structured shareholder agreement becomes a testament to a company's commitment to governance and transparency, therefor enhancing investor confidence. In an environment where trust is paramount, businesses with comprehensive shareholder agreements are better positioned to attract and retain investors, fostering a positive trajectory for growth.
Next Steps
If you believe a shareholders’ agreement is right for your or your client’s business, contact our experienced team via email at [email protected] or phone on 8414 3400. Let us guide you through the necessary steps to protect your business. Act now to establish a solid foundation for growth.