Shareholder agreements – Why Bother?

When people come together to develop a business they normally have roughly the same aspirations and goals.  In the early years they work together effectively to achieve the common business goal.

Unfortunately like marriage disputes shareholder disagreements are quite common.

Certainly a change in economic circumstances can cause shareholder disputes but it is not the major cause.  I think that shareholder disputes are quite common simply because people change over time.  Their views of the world in their 20s and 30s may be quite different to when in their 50s and 60s.

Things which may change your attitude to your business could be:

1. financial difficulties;
2. attitudes to risk;
3. family responsibilities;
4. health and age;
5. what is considered to be success; and
6. perception of unequal contribution of shareholders.

Our advice to businesses is that they should get a shareholders agreement done whilst everyone has the same general view as to how the business should be run and developed. It is almost impossible to get a shareholders agreement done when the shareholders openly dispute or even when nothing has been said they have become uncomfortable with each other.

It is often difficult to get shareholders agreements done when in the early stages of a business as they are often regarded as a distraction or an extra cost. We often get the response that the shareholders agreement can be done later on when things are going well and there are funds available and time to adequately prepare a shareholders agreement. In these circumstances, it may be best to prepare a relatively simple shareholders agreement and cover only non-controversial issues such as the purchase of capital equipment and then review the shareholders agreement annually and add the more controversial and complex issues over time.

The law does not deal particularly well with shareholder disputes. Whilst the constitution of a company may deal with some issues, they normally do not deal with major issues adequately or at all. The constitution of a company may not properly deal with decisions whether to buy or expand the business. In some cases a shareholder will go to court under the Corporations Law and request that the company be wound up in what lawyers call “a just and equitable basis”. This is requesting the court to wind up a company because as the words say, this is a just and equitable outcome. The problem is that the business could still be operating profitably and effectively even though the shareholder/directors cannot stand the sight of each other, a court may simply refuse to wind up a company, leaving all of the participants to continue in an unhappy marriage.

Another reason to have a shareholders agreement done is simply the cost associated with any litigation. The two elements of the costs are:

1. legal costs of a dispute; and
2. business opportunity costs.

In my experience the costs associated with shareholder litigation are 20 or 30 times that associated with having a proper agreement drawn.

With serious shareholder disputes a business can be disrupted by the dispute so that there is nothing left to argue over. An example would be that you’re a manufacturer but you’ve had a sleepless night, thinking about the problems that you’ve got with your other shareholders. You spent the previous night speaking with your spouse, your relatives and your lawyers and by the time you get to work your already exhausted. The first task that appears in your calendar for the day is to call one of your customers. You know why he is calling – it’s because a delivery is running late and you don’t even have the energy to deal with the problem and you lose a customer.

An example in a real estate company would be similar. You’ve had a sleepless night, spent the night speaking with spouse and lawyers, you come to work the following morning and the first message that appears on your screen is for you to call Mr X. You know why he is calling, for the second time, you have described his house as 4 bedrooms, when it has 5. You just can’t face the call, so don’t make it. You end up with a very unhappy customer, possibly to the point where the customer becomes an enemy of your business.

I’m not trying to say that shareholders agreements would save all disputes but they certainly give a framework for dealing with disputes and also deal with the major issues that can come up during the life of a business.

A shareholder agreement can deal with the following:

Capital Contributions

• Who?
• What happens if someone doesn’t contribute?

Transfer of shares

• How should you deal with a transfer of shares?
• Other shareholders obliged to offer their shares to the existing shareholders?
• What happens if they don’t want to buy?

Death or Disablement of a Shareholder

• i.e. could the family take over the shareholder’s interest?

Directors

• Who and how many?
• Who should be a chairperson and how many directors are required for quorum?

Financial

• Are there any shareholder loans to the company?
• Who decides whether the business is to borrow to expand?

Sale to third parties

• Who decides if a business is going to be sold to an independent third party?

If you haven’t done a shareholders agreement I strongly suggest that you do. I think the day you have a dispute or a major decision is to be made you will be glad you went to the trouble.

Author: John Turnbull

Recent Article Published in Gateway News – July 2009