Posted by Regie Anne Gardoce on 10 September 2019
So you’ve just set up a company and might be asking yourself: what’s next?
You might have heard others tell you that you need a Shareholders Agreement and Company Constitution.
They are the key foundational documents you’ll need when setting up a company – so you’re on the right track!
But, like many founders and business owners, you might be confused about what they are and how they’re different.
There are many types of companies but, put simply, there are the shareholders who own the company, and the directors who manage the day-to-day affairs of the company.
Since there are various people and roles that make up a company, it’s important to put the right legal documents in place to address:
- Rights and responsibilities of shareholders and directors
- Rules on running the company (meetings, special decisions)
- Holding and transferring shares
- Processes for disputes
What “the right legal documents” are depends on how your company is set up, the shareholding structure, board composition, and the risks of your particular business.
This article will discuss Constitutions and Shareholders Agreement – their purpose, their differences, and whether you need either or both for your company.
What Are They And How Are They Different?
A Constitution is a set of ground rules about how the company will be run, including the directors’ powers and duties, holding of meetings and voting.
Meanwhile, a Shareholders Agreement usually sets out more specific, detailed rules around the relationship between shareholders and directors, and how the capital in the company can be held and transferred.
And that’s the basic difference.
Legal industry practice is that Constitutions are quite general, while Shareholders Agreements are more specific.
There can be a crossover between the two – hence all the confusion!
On one hand, a Constitution may specify rules around issuing and transferring shares.
On the other hand, a Shareholders Agreement can do that while including more specific rules, for example:
- Valuing shares
- “Drag” along and “Tag” along rights
- Events of default
- Share vesting
If you have both a Constitution and a Shareholders Agreement, they need to be carefully drafted to minimise crossover and ensure consistency.
So that’s how a Constitution and a Shareholders Agreement are different.
But, just how important is it to have each document?
Why Should I Have A Constitution?
So, we know that a Constitution is a formal and broad document that governs the way a company is managed.
Even though the Corporations Act sets out some basic rules on how to govern a company, it’s important to have a Constitution to cater for more specific scenarios.
Also, having good processes formally set out in writing can be very useful to keep your company on track.
How Do I Get A Company Constitution?
If you don’t yet have a Constitution – don’t stress!
When you register your company, most incorporation providers will give you a standard Constitution.
Even if you don’t have one, the Corporations Act has “replaceable rules” that will act as your Constitution.
They’re called ‘replaceable’ rules because, if they are not suitable for you, you can “replace” them with a Constitution.
If you’re not sure, it might be a good idea to seek a lawyer’s help and get some advice on your requirements.
What’s Usually Included In A Constitution?
A Constitution typically covers the following:
- Powers and duties of directors
- Issuing and transferring shares
- Holding annual meetings
- Voting on decisions at meetings
- How the company can enter into contracts
If you’re still not sure what else is included, you can have a look at the replaceable rules as a useful guide.
This is similar (but different!) to what you can expect to see in a Shareholders Agreement.
Why Should I have a Shareholders Agreement?
Whenever you have two or more shareholders in a company, it’s a good idea to have a Shareholders Agreement in place to protect everyone’s rights.
A Shareholders Agreement sets out how the control of the company will be divided between the shareholders and directors.
You might be thinking that, in the early stages, things may seem clear cut now between you and other shareholders.
But there are issues you might not expect to come up later down the track.
This is where a Shareholders Agreement comes in – it’s always helpful to have pre-agreed rules and processes in place.
And, often a potential shareholder will want to see some form of agreement before buying-in to your company.
Drafting a Shareholders Agreement from the outset makes sure that you and the other shareholders are on the same page, and potential shareholders know what they’re signing up for.
What’s Usually Included In A Shareholders Agreement?
A Shareholders Agreement specifically defines the relationship between the shareholders, the company and the directors.
A Shareholders Agreement would typically cover the following:
- Selling and issuing shares
- Appointing and removing directors
- Requirements for specific decisions
- First rights of refusal
Depending on how you want to structure your company and share capital, these details will need to be tailored to the specific needs of your company.
A good lawyer can help draft a Shareholders Agreement that reflects the interests of your company, and advise you on any other issues that you may not have considered yet!
Could I change a Constitution or Shareholders Agreement later on? How?
In short, yes.
As your business grows and time goes on, you may need to update your Constitution or Shareholders Agreement.
For example, you may need to change the Constitution if you move to a new company structure or respond to any changes to the law that requires you to do so.
Changing a constitution can be a bit tricky, as it will require a “special resolution” (which needs at least 75% of shareholders to vote for it to pass).
Or, if a new shareholder is coming on board, you may need to update the Shareholders Agreement to suit them too.
You could do this with a Deed of Amendment signed by all parties, or you can simply add a new shareholder through a Deed of Accession.
What To Take Away…
Constitutions and Shareholders Agreements are similar but ultimately different, important legal documents.
Constitutions are general, high-level rules about company governance.
Shareholders Agreements are more specific rules determined by the specific shareholders of that company.
It may be most efficient and cost-effective to rely on the replaceable rules or a template constitution, and only set out specific rules in a Shareholders Agreement.
What you should do ultimately depends on the size, structure and specific needs of your company, and a lawyer can help you figure out the way forward.
Talk to a lawyer
If you’d like to chat more about whether you need a Company Constitution or a Shareholders Agreement (or both!), we have a friendly team of expert lawyers who draft these legal documents everyday.
You can reach us at 1800 730 617 or email@example.com.
There may also be other documents you need – such as Terms and Conditions for your business and Employment Contracts.
If you’re not sure about what legal stuff you’ll need to do when starting a company, read our Business Legals 101 Guide or just get in touch with us!