If you’re starting a business and thinking of incorporating you should be aware that, while there are many benefits, incorporation comes with its own potential pitfalls.
For example, when a corporation is formed it will be issued with a constitution governing how the company can be run. This will usually be a stock standard document with little if any consideration given to the particular nature of your business. If you are the sole shareholder and director, this may suit you just fine. If, however, there are multiple parties involved then there is a real possibility that this could create problems, which may not become apparent until years down the track.
This is where entering into a shareholders agreement can be useful. It allows you to vary the terms of your constitution and have greater control over how your company is to be run.
Some areas where a shareholders agreement can be useful are:
Appointment of Directors:
While it may sound fair and equitable that a simple majority of shares should be able to appoint the directors of your company, what if you are in business with two other people, each owning one third of the shares and the two others decide that you don’t get a representative on the board? Under most constitutions this simply would be tough luck; however a shareholders agreement can allow that each shareholder has the right to appoint their own director who may only be removed by them. Obviously this gives you greater power to protect your interests and stay involved in the day to day running of your business.
Drag Along Provisions:
Imagine that you are the majority shareholder in a company and a third party wants to buy you out, but only if they can also buy the shares of the minority shareholders. Under a standard constitution you may be stuck relying on the willingness of the minority, however a shareholder agreement can contain provisions requiring a minority shareholder to sell their shares in these circumstances. And if you are that minority shareholder and don’t want to give up your company? Well, that same shareholding agreement can give you pre-emptive rights to buy the majority shareholding as a precondition to any sale.
Decisions of the Board:
Some business decisions are too important to be decided by a simple majority. Some decisions need to be made unanimously or not at all. The only person who will know what those decisions are is you. By entering into a shareholders agreement you get to determine which matters must be decided by all the directors, rather than some draftsman who does not even know what your business does.