Why a properly drafted shareholders agreement matters

Most private companies operate on a mix of the Corporations Act 2001 (Cth), the company's constitution and — if the shareholders have thought about it — a shareholders agreement. The first two set out the legal framework. The shareholders agreement sets out how the shareholders will actually deal with each other, particularly at the difficult moments.

The gap the shareholders agreement fills

The Corporations Act and a standard constitution cover:

• Company formation and public compliance.
• Directors' duties.
• Basic decision-making — resolutions, meetings, notice.
• Share issue and transfer mechanics.
• Winding up.

None of that tells the shareholders how they will resolve a stalemate, at what price one can buy the other out, what happens if a shareholder dies or divorces, or when a shareholder can be forced to sell into a larger transaction. Those are all matters of private contract — which is exactly what a shareholders agreement is.

Key matters to cover

1. Governance and decision-making

Which decisions can be made by directors alone? Which require a shareholder resolution? Which require unanimous consent — for example, issuing new shares, taking on debt above a threshold, selling major assets, changing the business? Reserved matters protect minority shareholders from being run over by the majority.

2. Board composition

Who has the right to appoint directors? A single 25% shareholder may be entitled to one director; a 50/50 partnership typically has equal representation and a chair role that alternates or is filled by an independent.

3. Share transfers

• Pre-emptive rights — before a shareholder can sell to an outsider, they must offer to the other shareholders.
• Permitted transfers — to family members or associated entities without triggering pre-emption.
• Forced transfers on defined events — death, incapacity, bankruptcy, cessation of employment.
• Valuation mechanism — accountant's determination, independent valuation, or an agreed formula.

4. Drag-along and tag-along rights

• Drag-along. If a majority accepts an offer for the whole company, they can require the minority to sell on the same terms. Preserves the value of an exit that requires 100% of the shares.
• Tag-along. If a majority accepts an offer to sell their shares, the minority can require the buyer to acquire their shares too. Prevents the majority from cashing out while leaving the minority with a new and unwelcome controlling shareholder.

5. Deadlock resolution

For 50/50 companies, deadlock provisions are essential. Common mechanisms:

• Escalation to shareholders (or their nominees) for negotiation.
• Mediation.
• Independent expert determination on a defined issue.
• Buy-sell provisions — often "shotgun" or "Texas shootout" clauses whereby one shareholder names a price and the other elects to buy or sell at that price.

6. Restraint of trade

Shareholders — particularly employee-shareholders — should be subject to reasonable restraints on competing with the company during their shareholding and for a period after exit. Restraints must be reasonable to be enforceable.

7. Confidentiality and intellectual property

Confidentiality obligations survive the exit. Where founders develop IP for the company, the shareholders agreement (and related employment or consultancy agreements) should confirm ownership vests in the company.

8. Dividends and drawings

The default position is that dividends require director recommendation and are declared by the company. Many shareholders agreements set expectations — for example, a target dividend distribution percentage of profits, subject to solvency and working capital requirements.

9. Death, incapacity and family law

What happens to a shareholder's shares on death? A cross-option or a compulsory sale-and-purchase, often funded by insurance. What if a shareholder becomes incapacitated? Or if a shareholder's marriage ends and the shares are drawn into a family law property division? Each of these can destabilise a business unless addressed in advance.

10. Dispute resolution

A staged mechanism — negotiation, mediation, then arbitration or court — with clear jurisdiction and governing law.

The cost of not having an agreement

Common outcomes where no agreement exists:

• A 50/50 deadlock that ends in a winding-up application, destroying value on both sides.
• Minority shareholders excluded from significant decisions with no protection.
• A departing shareholder unable to sell at a fair price because there is no mechanism.
• An outside buyer acquiring a minority stake because pre-emption rights were never drafted.
• A family law claim over a share portfolio the other shareholders cannot influence.

Interaction with the constitution

The constitution is a public document filed with ASIC. The shareholders agreement is private. Some provisions — pre-emption, drag and tag — sit better in the constitution because they bind successors in title. Confidentiality and specific commercial arrangements sit better in the shareholders agreement. Careful drafting keeps the two documents consistent.

Reviewing an existing agreement

Agreements drafted at start-up rarely still fit ten years later. Common triggers for review:

• A new investor.
• Departure or death of a founder.
• Significant change in company value.
• Move from single-jurisdiction to multi-jurisdiction operations.
• Intergenerational transition.

For advice on preparing or reviewing a shareholders agreement, see our commercial contracts service and the broader commercial law area.

What a shareholders agreement adds to a constitution

A company's constitution and the Corporations Act 2001 (Cth) set the baseline for how a company is run. They do not, however, cover many of the questions that most matter to the shareholders of a small or medium business: how directors are appointed and removed, how decisions are made, how new shareholders are introduced, how existing shareholders exit, how the company raises additional capital, and how the parties handle a dispute. A shareholders agreement is the contract that addresses those questions.

Common terms

• Board composition and voting on reserved matters.
• Dividend policy and treatment of retained earnings.
• Pre-emptive rights on issue of new shares and transfer of existing shares.
• Drag-along and tag-along rights on a sale of the company.
• Good leaver and bad leaver provisions on the exit of a founder.
• Confidentiality and restraint of trade on departing shareholders.
• Deadlock and dispute resolution mechanisms.

Interaction with tax and estate planning

A well-drafted shareholders agreement interacts with the shareholders' personal estate planning — in particular, what happens to a shareholder's shares on death or loss of capacity. Some agreements include buy-sell arrangements funded by insurance; others rely on the shareholder's estate planning to deal with the shares. The right choice depends on the size of the business, the number of shareholders, the availability of insurance and the tax position.