In the bustling world of construction, where projects come in all shapes and sizes, establishing a solid foundation for your construction business is crucial. One often-overlooked but vital tool in achieving this is the shareholders agreement.
Whether you are a seasoned construction industry pro or just starting your own venture, understanding the benefits of shareholders agreements can be a game-changer for both protecting your significant investment, and sustainably expanding your construction business.
This article will provide a high-level run down of why a company may consider implementing a shareholders agreement or amending its current shareholders agreement.
What is a shareholders agreement?
A shareholders agreement is a contract that governs rights and relationships of a company’s shareholders and, sometimes, its directors. Usually, a shareholder’s agreement becomes relevant when the company expands to include more than one shareholder.
A shareholders agreement outlines each shareholder’s rights, interests and obligations in relation to each other and the company.
Of course, there are as a broad range of matters that a shareholders agreement might address, depending on the needs of the company and its business.
Why do I need a shareholders agreement?
Fundamentally, shareholders agreements help manage risk and govern decision making in a growing company.
One of the most important reasons to implement a shareholders agreement is to avoid unnecessary conflict, whether this is in relation to decision-making or ownership.
Shareholders agreements can help maintain stability, transparency, and fairness within construction companies, which can be especially valuable in an industry where projects can be complex and require coordinated efforts among multiple stakeholders.
Shareholders agreements provide a necessary structure by setting out processes for a wide range of matters, including:
- which shareholders have a right to vote for a director on the board;
- when and how shareholder meetings are to be carried out;
- in what circumstances may a company issue shares or implement a share scheme;
- buying, transferring, and selling shares; and
- how shareholders are to resolve a dispute.
If directors are included in the document, the shareholders agreement can also help lay a strong foundation for day-to-day decision making, board governance and the strategic direction of the company.
An effective shareholders agreement should set out the process for resolving disagreements. For example:
- what happens if there is a dispute about the allocation of shares or equity ownership?
- what happens when there is a dispute about appointing or removing a director?
- how do shareholders resolve conflicts related the sale of transfer of company assets or ownership, including where minority owners don’t want to sell?
- how do you break a deadlock, which leads to a standstill in company operations?
What if my company already has a company constitution?
A company constitution will often be limited to setting out the minimum requirements of the processes and internal administrative matters of a company under the Corporations Act 2001. In many cases companies do not even have a bespoke constitution, and instead simply rely on the “model” or default rules.
Either way though, a constitution will usually not protect shareholders’ interests to the level of detail described above.
A shareholders agreement can also complement and expand upon the company constitution with regard to the company’s objectives.
Shareholders agreements commonly include a provision to the effect that the shareholders agreement is to prevail in the event of any inconsistency. This is because the agreement is usually prepared later in time, often after the stakeholders have more experience with the company in question than was known at the time the constitution was prepared.
When is the best time for my company to implement a shareholders agreement?
Ideally, a shareholders agreement will be implemented as soon as a company consists of more than one shareholder.
Specific triggers to consider a shareholders agreement include:
- immediately on startup if you have more than one shareholder;
- bringing directors or shareholders;
- incentivising employees;
- incorporated joint venture agreements;
- enticing investors; and
- preparing for and managing exit events.
We understand that in the excitement of starting a new venture, many co-directors or shareholders don’t want to get bogged down in paperwork.
However, sitting down to discuss rights, responsibilities, decision-making and dispute resolution when everyone is getting along well (i.e. before the pressures of a new business mount too high) is probably the best time to do it.
Bringing on Directors or Shareholders
You should consider implementing a shareholders agreement when issuing or transferring shares to a new key stakeholder in your business.
Specifically, depending on the relationship, as the founder of a company, you may wish to reserve certain rights or decision-making powers rather than allow an incoming person to have all the same rights that you do.
The following example illustrates the importance of a shareholders agreement:
- Ben is the sole owner of B Construction Pty Ltd and wishes to provide 50% of company shares to John.
- John has managed the company for over 10 years and has always been loyal to B Construction Pty Ltd. Ben is confident that John will only act in the best interests of the company.
- After 5 years, B Construction Pty Ltd doubles in both size and value. John believes he should be entitled to a large share of the distributed dividend, in return for his key role managing the company.
- John also believes that when Ben transferred the shares, Ben had promised that John would receive a larger share distributed dividends in future if B Construction Pty Ltd is successful.
- Ben does not agree with John and as the founder of the company believes he is entitled to 50% of the distributed dividends. Ben also believes that only he can alter the process for dividend distribution.
- Without a shareholders agreement in place to clearly set out both the dividends that Ben or John are entitled to and to provide a dispute resolution mechanism, John may take the dispute to court and engage in lengthy and costly legal proceedings.
It is important to take the future into consideration as circumstances and relationships may change dramatically down the track. Promises, representations, discussions and meetings are common in these kinds of negotiations, but memory is a fickle thing and you don’t want to be involved in an argument down the track about who said what.
Issuing or transferring shares to company employees can be a valuable strategy to motivate employees by granting them an ownership stake in the company.
For employee shareholders, it is important to establish what process occurs if the employee ceases employment at the company or no longer wishes to hold shares. The reason for and timing of the employee shareholder’s cessation may make a significant difference to the process that unfolds after they leave.
Incorporated Joint Ventures
Common to the construction industry, incorporated joint ventures allow companies to join forces to tackle large projects and share industry specific knowledge and assets.
It is common for a director’s seat to be taken by the incorporated joint venture’s shareholders. As directors act for both the shareholder company and the incorporated joint venture, a shareholders agreement may allow or restrict directors from acting in the interest of the shareholders company.
A shareholders agreement can be used to set out the agreed arrangements, including:
- which entity will retain ownership of certain assets and when ownership may pass to the company; and
- particular restrictions on how the incorporated joint venture can raise capital and receive funds when necessary.
Providing comfort to investors
A clear shareholders agreement may provide comfort to potential investors by setting out parties rights and protections, allowing investors to invest with confidence knowing their rights are documented and protected.
The right to review a company’s books will regularly be found in shareholders agreements and is often attractive for investors. However, it will be important to ensure any information that may be sensitive to the company is to remain confidential.
Prepare for and manage exit events
Exit events may be near or have not yet crossed your mind.
A shareholders agreement can set out the valuation method for shares sold or transferred in an exit event. The valuation method may differ depending on the amount or type of shares held by a shareholder.
The valuation method is important as it determines what the shares may be worth in the future and whether they may be a good investment.
Setting up a shareholders agreement can help your company attract quality investment to help your business grow. It can also help avoid unnecessary disputes that will inevitably accompany that growth, as more interested parties become involved.
Construction companies should consider implementing a shareholders agreement as soon as possible and before disputes arise. Construction companies should ensure their shareholders agreements adequately reflect the goals and objectives of the shareholders.
If you need any help with preparing or reviewing a shareholders agreement, feel free to reach out.