The short answer is – if there is more than one shareholder in your firm (or you plan for there to be) – yes, you need a Shareholders’ Agreement.

I have worked with quite a few companies on developing and revising their Shareholders’ Agreement – even though I am not a lawyer – and here I share some of the key points I have found to be important in the New Zealand context.

A Shareholders Agreement is a contract between the shareholders that defines the basis of the agreement between the shareholders regarding the operation and governance of the firm. The agreement is generally drafted by the firm’s lawyer, and it can be a good idea for each shareholder to have their own lawyer look over it as well before it is finalised. In all cases, the lawyers used to draft and review should have good experience with the Companies Act 1993 (and amendments) and general commercial law. Make sure you ask your lawyer if they are comfortable with these areas of law to ensure they are well positioned to advise you.

Where a business advisor can assist is in the discussions and workshops amongst the shareholders to set the requirements of the Shareholders’ Agreement, develop the framework that is to be used, and then hand that over to your lawyer for drafting and finalising. This approach is designed to be more cost effective than having a room full of lawyers, and aims to ensure all of the shareholders have a chance to be heard before drafting.

Your Shareholders’ Agreement is part of your firm’s Corporate Governance processes – which helps define the rules of the relationship between the shareholders and the company directors. Remember, the shareholders own the company, but are not responsible for running the company: this is the role of the directors and management. This can become somewhat confusing where some or all of the shareholders work in the company. On a day-to-day basis, the shareholding employees do not wear the hat of a shareholder. They are an employee, reporting through to the CEO or Managing Director.

While in most cases issues of corporate governance you might see discussed in the media are focused on large firms with a broad shareholder base (e.g., a company listed on the NZX), the best practices also apply to smaller private firms as well.

But We Already Have a Company Constitution

A Shareholders’ Agreement and the Company Constitution are separate documents, and you should probably have both – but in most cases you are not required to have either. They both address matters of corporate governance for the firm, and matters relating to shareholders, such as:

• How the shareholders hold meetings (e.g., General Meetings) and make decisions at those meetings (such as proxy voting, the quorum required)
• How company directors are appointed and removed
• How often the directors need to meet (Board Meetings), the appointment of the Board chair, and how decisions are made (e.g., does the Chair have a casting vote in the event of a tied vote of the directors)
• How shares can be transferred between the existing shareholders, and any rules for the sale of shares to new shareholders
• How the company can issue new shares, e.g., to raise new capital

This is not an exhaustive list, just intended to show the types of matters you might cover.

The constitution is a legal agreement between the shareholders as to the way the firm is operated and governed. The terms you might want in a Shareholders’ Agreement can instead be in the constitution, and (to a large degree) vice versa. Where the various rules are placed will depend on the desired visibility of those terms.

If your company hasn’t adopted its own constitution, the rules that apply to the operation and governance of the firm default to those provided for in the Companies Act 1993. You may have adopted the default constitution offered by the New Zealand Companies Office at the time of incorporation (or later, if approved by a special resolution of the shareholders). Alternatively, you may have used one developed by your lawyer, either their boilerplate version, or a bespoke agreement developed for your company.

The constitution is a public document: anyone can access it via the New Zealand Companies Office website. Whenever the company changes its constitution, you must provide a copy to the Companies Office within 10 business days.

The Shareholders Agreement

The Shareholders’ Agreement is not public. It is a confidential legal document between the shareholders – although there are other parties you may need to provide with access, such as your bank, major customers, and suppliers. The agreement will also be disclosed during due diligence if the business is taken to market, and provided to prospective new shareholders when they are considering buying shares.

It is this confidentiality that can make a Shareholders’ Agreement appealing. The rules that apply to the shareholders – to which they have agreed – do not need to be disclosed publicly to third parties without the assent of the shareholders.

In most cases, the goal of developing a shareholders’ agreement is to ensure all shareholders – particularly minority shareholders – are treated fairly and equitably. In almost all cases, a shareholders’ agreement will determine in advance how various matters are to be addressed if they occur, for example:

• The rights and obligations associated with the issuing new shares – particularly protecting existing minority shareholders from having their shareholding diluted inequitably.
• Issuing new classes of shares, particularly allowing for non-dividend earning or non-voting shares
• The default dividend and distribution policy
• The appointment and removal of directors
• How an existing shareholder goes about selling their shareholding (in all or part) to other shareholders, or to non-shareholders. This should also allow for a change of ownership of shares due to relationship dissolution (‘Divorce Clause’), ill health, or as part of an estate in the event of a shareholder passing away.
• The offering of shares or options to any party, e.g., as part of remuneration packages
• The process and rules for share buy-backs by the company
• Acquiring another company (a ‘significant transaction’)
• Being acquired
• Follow-along and carry-along provisions
• Raising debt, financial guarantees from either shareholders or directors
• Related Party Transactions, including shareholder perquisites
• Share valuation model/approach, e.g., a fair price formula, whether any discounts apply to any shares
• Closing the company, winding up
• Transferring (e.g., selling or gifting) company assets to external parties
• Obligations or restrictions imposed upon shareholders while they hold shares in the company, and after they have sold (e.g., non-solicitation and non-competition clauses)
• Dispute resolution mechanism between shareholders, and whether the dispute resolution mechanism is mandatory and binding

Again, this is not an exhaustive list, but should illustrate the breadth and nature of the issues that should be considered for inclusion.

I’m The Only Shareholder – Why Would I Want a Shareholders’ Agreement?

In most cases, you won’t need one. The obvious exception is when you are thinking about bringing in new shareholders. If you are in start-up mode, this might be the case.

Rather than wait until the new shareholder/s are on board, it can be far more effective for you to define the terms you want in the Shareholders’ Agreement, which is then presented to the prospective shareholder/s. This can work well if you are dealing with individual investors and employees but is unlikely to work if you are dealing with a venture capital firm, private equity provider, or an experienced, professional investor. These investors may even have their own boilerplate Shareholders’ Agreement that they require you to sign.

It’s Only Ever Going To Be My Spouse and me as Shareholders

Many of the situations I see where a Shareholders’ Agreement would have provided strong guidance relates to relationship dissolution. The business goes from having two shareholders amicably operating on the same page to having two shareholders disagreeing about everything to do with the operation and ownership of the firm. Even if you have a pre-nup for your relationship, it pays to also have a Shareholders’ Agreement that spells out what happens to the firm in the event of a relationship ending – so-called ‘Divorce Clauses.’

What are the Downsides?

In general, the shareholders will be better off with a Shareholders’ Agreement than without. In general.

An effective Shareholders’ Agreement needs to balance the rights and responsibilities of all of the shareholders. It is not simply a way of balancing the relative voting power of a majority shareholder and the rest of the shareholders. Furthermore, beyond some fundamental protections of minority shareholder rights, it is not about creating a more ‘democratic’ shareholding environment. The major shareholder/s will still have effective control.

The provisions of the Shareholders’ Agreement may have an impact on the valuation of the firm, or on the valuation of specific parcels of shares – particularly the small/minority parcels.

Get agreement before issues arise. It will be very difficult to make changes to the Shareholders’ Agreement if there is significant dissent between the parties.

Another issue I have seen arise is around the perceived cost of developing the Shareholders’ Agreement. This is often the case when there are numerous lawyers in the room, with costs being borne by both the firm and the individual shareholders. In most cases, I keep the lawyers out of the workshops and discussions. In a few cases, it has been useful to have the company lawyer in the room for some discussions. I have also had a small number of engagements where a lawyer was involved to act as a mediator to resolve intrenched positions.

Finally, some see the need to comply with the rules set out in the Shareholders’ Agreement as being a downside. If the shareholders have developed the agreement in good faith, and their wishes have been faithfully represented in the final version drafted by the company lawyer, compliance is in everyone’s interest. Where there can be issues is where the level of detail has been too granular, and where the scenarios considered were not adequate. These can be largely addressed by ensuring you have the right experience from your professional advisors.

Where To Start

Working through the issues associated with a Shareholders’ Agreement for your firm starts by looking at the common scenarios that can happen, and discussing these with the shareholders as a group. In most cases, the process starts with a comprehensive questionnaire provided by your lawyer or advisor.

I prefer to have each shareholder initially work through the shareholders’ questionnaire on their own, and then I collate the responses, and run one or more workshops with all the shareholders in the room to get agreement. The Shareholders’ Agreement is then drafted by the company’s lawyer, and then reviewed by each shareholder and their advisors.

One of the early requirements that needs to be set is the shareholder proportion required to make changes to the Shareholders’ Agreement. Changing the company constitution requires 75% of shareholders (based on their shareholding) to agree. In some cases, changes to the Shareholders’ Agreement sets a lower bar (e.g., 51%), and in others much higher (e.g., 89%). It is even possible to set different rules for different clauses in the agreement if that is desired.

It is prudent for shareholders to review the Shareholders’ Agreement every two years or so to ensure it still covers the scenarios of concern by the shareholders, and that the mechanisms included are still appropriate. The best time to be reviewing and updating a Shareholders’ Agreement is before significant matters arise, where possible. Think of it like a pre-nup – even though there is typically much more to a Shareholders’ Agreement – get agreement before it is needed.