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10 common risks associated with shareholders agreements.

1. Failing to have a Shareholders Agreement

Whether a person or entity is becoming a shareholder in a new company or an existing company, they should be mindful to check whether there is a shareholders agreement.

In the absence of a shareholders agreement, shareholders will need to rely solely on the company’s constitution to set out all of the administrative processes – if the constitution has been prepared in a mostly pro-forma or standard form, it is unlikely that it will provide all that is needed.

2. New Shareholders

It is important to ensure that a company’s constitution or a shareholders agreement provides that any new shareholder entering into an existing company is obliged to enter into and be bound by the terms of the shareholders agreement.

There is more than one way that this can be done. The constitution can provide that the company only registers a transfer of shares if a deed of accession has been signed by the incoming shareholder and provided to the company.

3. Restrictions on Company’s Powers

The terms of a shareholders agreement cannot act to limit the corporate powers of a company under the Corporations Act 2001 (Cth) (Act). If a term within a shareholders agreement is deemed to limit such powers, then it is likely to be void.

Anyone involved in the preparation of a shareholders agreement should be mindful of the powers given to a company under the Act when completing a shareholders agreement.

4. Restraint of Trade

It is common with small to medium sized companies, where the shareholders also hold director or employee positions, that restrictions are included within the shareholders agreement on the types of activities and work that the shareholders can complete, to limit the risk of any shareholder undertaking activities that compete with the company – this can be both whilst the person remains a shareholder and for a period after they cease to be a shareholder.

Without the inclusion of this type of clause, there is a risk of dispute particularly when a person ceases to be a shareholder and seeks to start or work in a competing business. Any clause restraining a person’s activities needs to be carefully drafted to ensure that the correct entities are restrained, and so that the clause is enforceable if needed.

5. Management Decisions and Shareholder Obligations

Depending on the type, size and nature of the company the shareholders may wish to retain a level of control and involvement in the management and operation of the company.

Shareholder involvement in the company’s management is unlikely to be addressed in a standard constitution, so if this is a specific concern of a particular shareholder or group of shareholders, it needs to be set out in a shareholders agreement.

There are different ways of addressing this issue within a shareholders agreement, none of which are standard and will depend on the nature of the company’s business and the expectations of the shareholders.

6. Financials

If any shareholder or prospective shareholder wants to have control over certain financial decisions or be provided with business plans or other financial projections at any time, a standard constitution would not generally include this right. A shareholders agreement can be used to state which decisions need to be referred to the shareholders, eg for decisions with a liability or cost in excess of a set amount.

If the shareholders want these types of rights in relation to decisions, but a shareholders agreement has not been entered into or has not been drafted specifically to cover off on this type of concern, then the company could make decisions that are not in line with the intentions of the shareholders.

7. Capital

There is more than one circumstance in which capital investment becomes a consideration for a company.

Where there is a start-up company, it will usually seek initial funding, which is generally as cash in exchange for the issue of shares. However, it is important to remember that not all shareholders provide cash as consideration for shares.

8. Issuing or Transferring Shares

A company’s constitution often details the process for issuing or transferring shares. Depending on the provisions included in the constitution together with the circumstances of the shareholders involved, it may be that the process needs to be further set out, or additional circumstances may need to be provided for in a shareholders agreement.

9. Dispute Resolution:One of the main advantages of a shareholders agreement is to include a process to resolve a deadlock or dispute between shareholders.

10. Consistency with Constitution:It is important that any shareholders agreement is drafted with careful consideration of the matters that are addressed within the company’s constitution, so that the two documents governing the company’s affairs and the relationship between the shareholders are not inconsistent with each other.

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DR NAVEEN PRASADULA

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