Introduction
When establishing a company, there are two documents that play a critical role in defining a company’s structure, rules and governance: the company Constitution and the Shareholders Agreement.
Despite the importance of these documents, there are often questions about whether only one, both or neither are necessary.
This article explores the importance of these documents, their relationship, and why they can both be considered necessary for your company.
Company Constitution
A company Constitution is a formal set of rules that governs the internal management of a company and its business. A Constitution can take various forms. If no explicit Constitution is made, then the Constitution is taken to be the replaceable rules set out in the Corporations Act 2001 (Cth). The replaceable rules provide a basic framework for internal governance in a company.
Alternatively, a Constitution excluding the replaceable rules can be created to suit the Company, or a mixture of rules specific to the company and the replaceable rules can be crafted into a company Constitution. Unless otherwise stated or provided for in a Constitution, the replaceable rules will apply.
The company Constitution and the replaceable rules act as a contract between the company and its directors and shareholders as well as between the shareholders themselves.
There is no standard form Constitution that may be used to govern these relationships; each company Constitution will vary based on what shareholders decide are the needs of the business.
However, at a high level, a Constitution should address matters that deal with the day-to-day management of the business, including but not limited to:
- How directors are appointed and removed;
- Directors’ powers;
- How director and shareholder meetings are to be called and held;
- How shares are to be issued or transferred; and
- How disputes are to be resolved.
When starting a company, it is imperative to establish this document so the company can commence operating with an understanding of and clear guidelines surrounding its internal governance. However, a Constitution can be amended later on should the needs of the Company change, as long as at least 75% of the shareholders agree by way of a special resolution.
Shareholders Agreement
In comparison to a Constitution, a Shareholders Agreement is an agreement between the shareholders of the company that governs their relationship.
There is no standard form Shareholders Agreement, with each agreement varying based on the circumstances of the company and its shareholders. However, despite this, there are some topics that would be expected to be included in a Shareholders Agreement, including:
- Shareholder rights;
- How shares are to be issued and transferred to other shareholders or third parties;
- The composition of the board of directors;
- Events of default and what is to happen if one occurs;
- How and who is to make major decisions; and
- Processes on dealing with deadlocks and disputes between shareholders.
Even these somewhat ‘standard’ terms will vary depending on the nature of the business and its potential for growth. These factors may impact clauses in the Shareholders Agreement regarding drag along and tag along rights, employee share option plans and vesting arrangements.
It is important that a Shareholders Agreement be entered into, as conflicts can often arise between shareholders, whether they be minority or majority shareholders, which the Shareholders Agreement can address.
Is a Constitution and a Shareholders Agreement the same thing?
From the outset, it may appear that these two documents provide similar roles regarding the rights and obligations of the company, its directors and shareholders. However, this is not the case, as each document plays a unique role.
A company Constitution is created to provide the fundamental framework to guide the company’s operation and governance, focusing on the internal management of the company.
This is then supported by a Shareholders Agreement that offers flexibility and the ability to address specific shareholder concerns, relationships and needs, guiding the relationship between shareholders.
It strongly recommended that you prepare both documents to ensure that your company is prepped for success.
Conclusion
Whilst it can be overwhelming to establish a company, setting the correct foundations for your company’s success should not be overlooked.
Both a company Constitution and a Shareholders Agreement play essential roles in establishing and guiding the internal governance of the company as well as its relationships with and between key stakeholders like directors and shareholders.
It is important to have these documents prepared and suited to your needs from the outset.
The information in this article is for general purposes only and you should obtain professional advice relevant to your specific circumstances.
Get in touch
If you or someone you know wants more information or needs help or advice regarding establishing a company or preparing a company Constitution or Shareholders Agreement, please contact us.
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