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Protecting Your Shareholders’ Interests – How Important Is It And Where To Start

Commercial Law

As a business owner, it’s important to recognise the value that shareholders can bring to your business. Currently in Australia, the Corporations Act 2001 (Cth) s 181(1) states that directors and other officers of a corporation must exercise their powers and discharge their duties:

a) in good faith in the best interests of the corporation; and
b) for a proper purpose.

What does this realistically mean for businesses? The above legislation does not explicitly state that directors and other officers must discharge their duties in the best interests of shareholders. However, as found by the Australian Governance Institute, “case law has tended to grant primacy to shareholders’ interests.” This is because the legislation states that the director must act in the best interests of the business, which usually coincides with the best interests of the shareholders.

Why it’s important to protect your shareholders’ interests

Although you may not be legally required to protect the interests of your shareholders, it is still in the best interests of yourself and your company to do so. Your shareholder relationships can and will impact the wider ecosystem of your business, and spell the difference between profit and loss.

One of the primary benefits of having shareholders is that of funding. When it comes to raising capital, existing investors and shareholders are often the best source of funding (however it should be noted that unlike bond investors, shareholders do not receive periodic interest payments, or their initial investment back from the business).

Businesses hoping to eventually go public and be listed on the public stock exchange may also need the assistance of shareholders, with many stock exchanges worldwide insisting upon a minimum number of shareholders before listing. For example, to be listed on the ASX, businesses must have “at least 300 non-affiliated shareholders with holdings valued at a minimum of $2,000 each.”

Shareholders also play direct and indirect roles in the operations of a company, possessing voting rights on significant corporate decisions such as electing the directors who will then appoint and manage the senior officers of the business such as CEO and CFO. Furthermore, any decisions regarding a company’s stock or development of business units will also have to be approved by a majority of shareholders.

Where do I start?

When it comes to shareholder interests, it is crucial that the relationship is carefully managed and outlined. Currently under Australian law, a shareholder’s rights and obligations are governed by:

  1. The Corporations Act 2001 (Cth);
  2. The Constitution of the Company; and
  3. The Shareholders Agreement (if any)

The Corporations Act 2001

Full details of the shares under the Corporations Act 2001 can be found in Chapter 2 of the Act and covers:

  • Issuing and covering shares
  • Redemption of redeemable preference shares
  • Partly-paid shares
  • Capitalisation of profits
  • Dividends
  • Notice requirements
  • Transactions affecting share capital

It also covers a shareholder’s general rights including:

  • Voting rights (as per share class)
  • Right to receive annual company reports
  • Pre-emptive rights to issuing of new shares
  • Right to receive dividends
  • Right to remove directors with majority shareholder favour

The Company Constitution

Your constitution will vary depending on the needs of your business. Generally speaking however, it will address the daily running and management of your business and will include points including:

  • The appointment and removal of directors
  • The powers of directors
  • Notice and holding of directors’ meetings
  • Rights of shareholders based on share class
  • Conflict resolution and mediation

3. Shareholders’ Agreement

A clear and comprehensive shareholders’ agreement is arguably one of the most crucial contracts when issuing shares in your company. This private contract is used to regulate and control the company’s ownership and directorship, but is also used as a means to protect shareholder interests (and in particular, minority shareholders). As with company constitutions, there is no “official” format for your shareholders’ agreement. However, standard clauses can include:

  • Shareholder funding/contributions
  • Director appointments
  • How the company will be managed (including % of approval required for decisions)
  • Roles and obligations
  • Dividends and financing
  • Buy-sell provisions
  • Transfer of shares
  • Exit strategy
  • Events of default and consequences
  • Deadlocks
  • Non-compete and restraint of trade

Although generic and boilerplate terms are available, your shareholders’ agreement can and should be tailored for the specific circumstances and operational needs of your business. Furthermore, a well-written agreement will greatly minimise the risk of future disputes of the running of the business and potential costs of a “business breakup”.

The team at AV Lawyers are experienced in setting up the best shareholder agreements and structure for your business. Get in touch with our team today to arrange a free consultation.