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Harrison Dell’s earlier piece, Shareholders Agreements: Complete Guide for Australians, covered the why and the what of a shareholders agreement at a high level. This is the companion article. It is for founders, advisers and investors who already know they need a shareholders agreement and want to understand how the individual clauses actually work, where they bite, and what we negotiate hardest at Cadena Legal.
The clauses in a shareholders agreement do real legal and commercial work. Each of them is the answer to a problem that has happened to other companies and will eventually happen to yours. The aim of this article is to walk through them, one by one, and explain what each clause is doing under the surface.
What is a shareholders agreement?
A shareholders agreement (commonly called a SHA) is a private contract entered into between some or all of the shareholders of a company, and usually the company itself. It sits alongside the company’s constitution and, where the two conflict, the SHA generally prevails as between the parties to it, with the constitution being amended in due course to reflect the SHA position.
Why does the distinction matter? Because the constitution and the SHA operate on different legal footings. The constitution has effect as a statutory contract under section 140 of the Corporations Act 2001 (Cth) between the company, each member, and each director and company secretary. The SHA has effect as a private contract between the parties who sign it. The SHA is therefore the appropriate home for arrangements that are sensitive (founder protections, valuation formulas, restraint periods) or that depend on personal commitments between specific shareholders (deadlock mechanisms, leaver provisions, drag and tag along arrangements).
Critically, the SHA is private. It is not lodged with ASIC. Nothing in it appears on a public register, and the parties can include commercially sensitive content that would be entirely inappropriate to commit to a constitution.
Why a constitution and the Corporations Act are not enough
Australian company law sets the floor. It does not set the ceiling. The Corporations Act and a standard constitution will tell you, in broad terms, who is a director, how meetings are convened, and how shares are transferred. What they will not tell you is what happens in any of the scenarios that actually break co-owned companies. There are three principal gaps.
First, the Corporations Act says almost nothing about the relationship between shareholders. It governs the relationship between the company and its members, and between the company and the world. The pre-emptive right of existing shareholders to be offered new share issues before outsiders is a replaceable rule that applies to proprietary companies (section 254D), but the rules around transfer of existing shares between shareholders, restraint of trade, leaver consequences, deadlock, drag and tag along, and reserved matters are not addressed at all.
Second, the default fallback when shareholders fall out is the statutory oppression remedy (sections 232 to 234 of the Corporations Act) and the derivative action regime (sections 236 to 237). Those remedies exist, and they work, but they are slow, expensive, public and entirely discretionary. A well-drafted SHA gives parties contractual rights they can enforce directly under their own contract, with a clear evidentiary record of what was agreed, often with arbitration or expert determination in place of court.
Third, investors expect one. Angel investors, family offices, venture capital funds and strategic acquirers will not subscribe for shares without a SHA, or its closer cousin, a subscription and shareholders agreement. Having a workable SHA already in place avoids renegotiating the bargain under deal pressure when capital is needed.
The clauses that do the real work
There is no single template that fits every company. The clauses set out below are the ones that we draft and negotiate in almost every commercial engagement, and the ones whose absence we most often regret on behalf of clients we are brought in to rescue.
1. Pre-emptive rights on issue and transfer
Pre-emptive rights have two flavours. The first is the right of existing shareholders to be offered any new shares the company proposes to issue, pro rata to their existing holdings, before the company offers those shares to anyone else. This protects existing shareholders against dilution. The second is the right of existing shareholders to be offered the shares of a departing shareholder before those shares are offered to an outsider, again typically on a pro rata basis. This protects the cap table from being polluted by unwanted third parties.
In a sophisticated SHA both flavours operate together. The clause sets the notice mechanics, the price (negotiated, formula-driven, or fair market value as determined by an independent expert), the time within which the right must be exercised, and what happens if it is not.
2. Drag along
If shareholders holding a specified majority of the issued capital (commonly 50 per cent, 75 per cent or some other negotiated threshold) wish to sell the company to a third party on arm’s length terms, the drag along clause entitles them to compel the remaining shareholders to sell their shares on the same terms. Drag along prevents a small minority blocking an otherwise sensible exit by holding out for a premium.
The terms negotiated around drag along matter as much as the right itself. Common protections for the minority include a floor price, an obligation that the consideration be cash or freely tradeable securities, a cap on the warranties and indemnities the dragged shareholder must give, and exclusions for related-party purchasers.
3. Tag along
Tag along is the mirror image. If a majority shareholder (or a controlling group) finds a buyer for its shares, the minority shareholders are entitled to require the buyer to acquire their shares on the same terms. Tag along stops the majority cashing out and leaving the minority with a new and unfamiliar majority shareholder.
Tag along clauses commonly distinguish between proportional tag (the minority can sell its pro rata share to the buyer) and full tag (the minority can require the buyer to take all of its shares). The choice is commercial, and depends in part on whether the company is sufficiently mature to support a partial exit.
4. Good leaver and bad leaver
Where one or more founders are employed in the business and have an equity stake, the SHA needs to address what happens when they leave. The market practice is to classify the departure as either a good leaver event or a bad leaver event, and to attach different consequences to each.
Good leaver events typically include death, permanent disability, redundancy made by the company, and retirement after a defined vesting period. A good leaver typically retains their vested shares, and may sell their shares at fair market value or be permitted to keep them as a passive holder.
Bad leaver events typically include resignation within a cliff period (often three to four years from the issue date), termination for serious misconduct, and material breach of restraints. A bad leaver is compelled to sell back at the lower of issue price and fair market value (sometimes at issue price only, sometimes with a discount), and any unvested portion forfeits outright.
The point of leaver provisions is not to be punitive. It is to align the equity with the value the founder is expected to create over time, and to ensure the company is not left carrying a passive shareholder who walked away from the work two years in.
5. Shotgun, Russian roulette and Texas shoot-out
These three names all describe variations on a theme: a mechanical deadlock-breaker designed to be used between two shareholders or two blocs of shareholders, where one party serves a notice naming a price per share, and the other party must either buy at that price or sell at that price.
The mechanism is brutal. It is also remarkably effective. The party who serves the notice has every incentive to name a price that is fair, because they may well end up on either side of the transaction. The party who receives the notice has a binary, time-limited choice. Litigation, by contrast, takes years.
In a Texas shoot-out, both parties simultaneously submit sealed offers and the higher offer wins, buying out the other. In a Russian roulette, one party names the price and the other chooses sides. Whichever variation is chosen, the procedural detail (notice period, payment terms, deposit, escrow, treatment of director resignations) matters enormously.
6. Reserved matters and board composition
A reserved matters clause sets out a list of decisions that cannot be made without the consent of specified shareholders, regardless of the headline majority. The list almost always includes amending the constitution, issuing new shares, taking on debt above a defined threshold, paying dividends, entering into related-party transactions, changing the auditor, winding up the company, and acquiring or disposing of material assets.
The companion clause sets out who appoints which directors and how board votes are taken. The default position under the Corporations Act is that proprietary company directors are elected by ordinary resolution of the members, with the directors managing the business under what is otherwise the replaceable rule in section 198A. A SHA can override this and provide that each major shareholder (or each major class of shareholder) appoints one or more directors, with quorum requirements that protect minority representation.
7. Deadlock resolution
Even with a clear reserved matters list and a clean board structure, deadlock can occur. A deadlock clause sets out a tiered procedure: escalation to nominated principals, mediation, expert determination, and finally a sale mechanism such as shotgun or third-party buy-out. The point of the clause is to ensure the company is not paralysed indefinitely while two shareholders refuse to speak.
8. Funding obligations and anti-dilution
If the company needs further capital, the SHA needs to address whether each shareholder is required to participate, whether they can decline, and what happens if they decline. Common approaches include mandatory pro rata subscription, voluntary subscription with anti-dilution protection for participating investors, and conversion of decline into preference shares or convertible loans.
The interaction with the Corporations Act’s pre-emptive rights regime and the company’s constitution needs to be carefully drafted, particularly where there are different classes of shares with different rights to dividends, capital and voting (the company’s power to issue different classes is anchored in section 254A of the Corporations Act).
9. Restraints, confidentiality and intellectual property
Founders who hold equity typically also hold the operational knowledge of the business. A SHA usually contains restraint of trade, non-solicit and confidentiality undertakings binding on each shareholder, with the restraint period and area calibrated to the nature of the business and the role of the relevant shareholder. Intellectual property assignment clauses, particularly relevant in technology and IP-rich businesses, ensure that any IP created by a founder in the course of the business sits in the company, not in the founder.
Restraints must be reasonable to be enforceable. The cascading drafting approach common in NSW (the Restraints of Trade Act 1976 (NSW)) provides flexibility, but in other states a poorly drafted restraint is at significant risk of being void in its entirety.
10. Information rights and reporting
Minority shareholders need access to financial and operational information about the company. A SHA typically requires the company to provide audited annual accounts, monthly or quarterly management accounts, an annual budget, board minutes, and notice of material events. The level of detail depends on the size of the holding and the nature of the shareholder; passive investors usually want less, active investors typically want more.
11. Dispute resolution and governing law
A clear dispute resolution clause specifies whether disputes are to be referred to mediation, expert determination, arbitration or court, and the governing law and jurisdiction. Arbitration is private and final and often appropriate for commercial joint ventures. Court is public and appealable and more appropriate where injunctive relief may be required. The choice should be deliberate.
In short
A shareholders agreement is cheap insurance against an expensive future. The time to put one in place is when the founders agree on everything, not when they no longer do. The clauses described above are not exhaustive, and the right balance between them depends on the size of the holding, the nature of the business, the personalities of the founders, and the path the company is most likely to take.
At Cadena Legal we work with founders at every stage, from two-person tech start-ups to family-controlled trading groups with eight-figure turnover, drafting and negotiating shareholders agreements that hold up when they need to. If you are about to take on a co-founder, bring on an investor, or formalise an arrangement that until now has run on a handshake, the time to talk to us is now, not later.
