Shareholder Agreement Lawyers

Founder vesting means that a founder's shares are subject to being bought back by the company or the other founders if that founder leaves within a defined period. In Australia this is usually structured as reverse vesting, where the founder holds the full parcel from day one and the company holds a buy-back right over the unvested portion, rather than the shares being issued progressively.

The standard schedule is four years with a twelve-month cliff, meaning nothing vests if the founder leaves in the first year and twenty-five per cent vests at the twelve-month mark, with the balance vesting monthly or quarterly thereafter. Lazarus Legal drafts vesting so that the buy-back price for unvested shares is the original issue price rather than market value, because a buy-back at market value defeats the entire purpose of the provision.

Vesting must be paired with good leaver and bad leaver definitions, and the definitions are where these clauses are usually won or lost. A well drafted agreement treats death, permanent incapacity and termination without cause as good leaver events attracting full or accelerated vesting, and treats resignation without cause, termination for serious misconduct and breach of the restraint as bad leaver events. Where bad leaver is drafted broadly enough to capture any resignation, the clause becomes a mechanism for forcing a founder out cheaply, which is a point Lazarus Legal raises whether acting for the company or for the individual.

Reserved matters are the decisions that cannot be made by the board alone and require shareholder approval at a specified threshold. Setting the list too short leaves a minority shareholder with no protection, and setting it too long makes the company ungovernable because routine decisions stall waiting for consent.

A workable list of reserved matters covers issuing new shares or options, changing share class rights, borrowing above a stated dollar figure, selling or licensing core intellectual property, acquiring or disposing of a business, appointing or removing directors, changing the dividend policy, entering related party transactions, and winding up or selling the company. Lazarus Legal recommends attaching a dollar threshold to the financial items rather than reserving all expenditure, so that the clause does not require a shareholder vote to renew an office lease.

The threshold itself should be chosen against the actual cap table rather than taken from a template. A seventy-five per cent threshold gives a twenty-six per cent holder a veto, which is meaningful protection for that shareholder and a genuine constraint on the majority. A unanimity requirement gives every shareholder a veto and is the most common cause of deadlock in agreements that are later disputed. Lazarus Legal models the threshold against the current and post-raise cap table before recommending a figure.

Drag along rights allow a specified majority to compel the remaining shareholders to sell into a third party offer on the same terms. Without a drag along, a single small holder can block a sale of the entire company, which is why acquirers regularly require the provision to exist before proceeding.

Tag along rights are the corresponding minority protection, allowing a minority shareholder to require that their shares be included in any sale by the majority on the same terms and at the same price. An agreement containing a drag along without a tag along is one-sided, and Lazarus Legal raises the imbalance in every review where it appears.

The drag along threshold is typically set between seventy-five and ninety per cent of shares. Lazarus Legal also drafts protections into the drag itself, including that the dragged shareholders cannot be required to give warranties beyond title to their own shares, that any liability is several rather than joint, and that the consideration must be in the same form so that the majority cannot take cash while the minority is dragged into scrip.

On death, a shareholder's shares pass to their estate, which means the surviving shareholders can find themselves in business with a beneficiary who has no involvement in the company and no interest in how it is run. The shareholder agreement should therefore contain a compulsory transfer provision triggered by death, obliging the estate to offer the shares and obliging the remaining shareholders or the company to acquire them.

The provision only works if the purchase can actually be funded, and this is where most agreements fail in practice. A buy-sell provision requiring the surviving shareholders to buy a deceased shareholder's stake is unenforceable in substance if the survivors do not have the money. Lazarus Legal drafts these provisions to sit alongside insurance funding, where each shareholder is insured for the value of their holding and the proceeds fund the buy-out.

The insurance structure and the drafting of the buy-sell need to be prepared together, because the ownership of the policy and the mechanism by which proceeds are applied affect the tax treatment of the transaction for both the estate and the surviving shareholders. Lazarus Legal coordinates with the client's accountant on the structure rather than drafting the legal document in isolation.

Shares or options issued to employees are taxed under Division 83A of the Income Tax Assessment Act 1997, and the default position is that the discount to market value is assessable to the employee in the year the interest is acquired. That produces the outcome employers most want to avoid, which is an employee receiving a tax bill on illiquid shares in a private company they cannot sell.

The startup concession in section 83A-33 defers the tax and shifts the eventual gain into the capital gains tax regime, but it is only available where the company meets every condition. The company must be unlisted, incorporated for less than ten years, have aggregated turnover of no more than fifty million dollars in the prior income year, and be an Australian resident company. The interests must be ordinary shares issued at a discount of no more than fifteen per cent to market value, or options with an exercise price at or above the market value of an ordinary share at grant, and the employee must hold for at least three years and must not hold more than ten per cent of the shares or control more than ten per cent of the votes.

Lazarus Legal drafts employee share plans against these conditions and against the shareholder agreement at the same time, because an employee share plan that issues shares outside the agreement's transfer restrictions creates a class of shareholders who are not bound by the pre-emptive rights, the drag along or the restraints. The valuation supporting the fifteen per cent test should be documented at the time of issue rather than reconstructed later, and this is a point on which the client's accountant should be engaged before the plan is executed.

Valuation is the provision that determines what every other provision in the agreement is worth, and it is routinely the shortest clause in the document. An agreement that says shares are to be transferred at fair value without defining the methodology, the valuer, or the appointment process has deferred the argument rather than resolved it.

Lazarus Legal drafts valuation provisions that specify whether the valuation is on a maintainable earnings basis, a net asset basis, or the higher of the two, and that state expressly whether a minority discount applies. The difference between a net asset valuation with a minority discount and an earnings-based valuation without one is frequently a factor of three or more on the same shareholding, so leaving it unstated is not a neutral drafting choice.

The appointment mechanism matters as much as the methodology. The clause should name the appointing body where the parties cannot agree, most commonly the president of the relevant professional body, should state whether the valuation is binding or open to challenge, and should allocate the cost. Lazarus Legal also recommends a differential valuation basis tied to the leaver definitions, so that a bad leaver receives issue price or net asset value while a good leaver receives full market value.

Deadlock arises where two shareholders hold equal voting power and neither can pass a resolution, and it is entirely foreseeable at the point the company is formed. A shareholder agreement between equal holders that contains no deadlock mechanism has left the parties with two options when they disagree, which are litigation and an application to wind the company up on the just and equitable ground.

The mechanisms available include an escalation clause requiring the dispute to go to the shareholders personally and then to mediation before any other step, a casting vote given to the chair or to a nominated shareholder on defined categories of decision, and a shotgun clause under which one shareholder names a price and the other elects either to buy at that price or to sell at it. Lazarus Legal drafts shotgun clauses with care, because the mechanism systematically favours the shareholder with better access to funding and is not appropriate where the parties have materially different financial capacity.

The alternative for unequal capacity is an independent expert determination or a structured sale process with an agreed floor price. Lazarus Legal selects the mechanism against the actual relationship between the shareholders rather than inserting a standard clause, because a deadlock provision that one party cannot realistically use is not a protection.

Restraint clauses in shareholder agreements prevent a departing shareholder from competing with the company, soliciting its clients, or poaching its staff for a defined period within a defined area. In most Australian jurisdictions a restraint that is drafted too widely is void in its entirety, which is why the cascading structure of alternative periods and areas became standard drafting practice.

New South Wales operates differently. Section 4(3) of the Restraints of Trade Act 1976 (NSW) allows the court to read down a restraint to the extent that it is not against public policy, rather than striking it out completely. That gives a restraint governed by New South Wales law a materially better prospect of partial enforcement than the same clause governed by the law of another state.

The practical consequence is that the governing law and jurisdiction clause in a shareholder agreement is doing more work than it appears to. Lazarus Legal considers the restraint and the governing law clause together, and notes that restraints attached to the sale or transfer of shares are generally enforced more readily than restraints in employment contracts because the court treats the departing shareholder as having been paid for the goodwill being protected.

A company's constitution takes effect under section 140 of the Corporations Act 2001 (Cth) as a contract between the company and each member, between each member and every other member, and between the company and each director. A shareholder agreement is a separate contract between the shareholders, and the two documents regularly say different things about the same subject.

Where they conflict, the shareholder agreement binds the parties to it as a matter of contract but does not automatically bind the company or override the constitution, particularly if the company is not a party to the agreement. That produces the outcome where a shareholder is contractually obliged to vote a particular way while the company is entitled to disregard the arrangement, and where a transfer restriction in the agreement does not prevent the directors from registering a transfer under the constitution.

Lazarus Legal addresses this in three ways. The company is made a party to the shareholder agreement, the agreement contains an express precedence clause requiring the shareholders to exercise their votes to amend the constitution where the two conflict, and the constitution itself is amended by special resolution under section 136 where the inconsistency is structural rather than incidental. Reviewing a shareholder agreement without reading the constitution alongside it is not a complete review, and it is the most common defect Lazarus Legal identifies in agreements drafted elsewhere.

Pre-emptive rights require a shareholder who wishes to sell to first offer their shares to the existing shareholders, usually in proportion to existing holdings, before any sale to an outside party. Without the provision, a shareholder in a proprietary company can in principle sell to anyone, including a direct competitor.

The replaceable rule in section 1072G of the Corporations Act gives the directors of a proprietary company a discretion to refuse to register a transfer, which is a partial protection but a weak one. It depends on who controls the board at the time, it can be displaced by the constitution, and it gives the blocked shareholder grounds to allege oppression if the refusal is not for a proper purpose.

Lazarus Legal drafts express pre-emptive rights with defined notice periods, a stated valuation basis for the offer, a mechanism for what happens to shares not taken up by the other shareholders, and an express prohibition on transfers to defined competitors regardless of the pre-emptive process. The clause should also address transfers to related parties and family trusts, because a transfer to a shareholder's own trust is usually intended to be permitted and will otherwise be caught by the restriction.

Dilution occurs when a company issues new shares and an existing shareholder's percentage falls, and it is a normal consequence of raising capital rather than a wrong in itself. The provisions that matter are the ones governing whether the existing shareholder gets the opportunity to maintain their percentage, and what happens if the new shares are issued at a lower price than they paid.

Pre-emptive rights on issue, which are separate from pre-emptive rights on transfer, give existing shareholders the right to subscribe for their proportionate share of any new issue before it is offered externally. Lazarus Legal drafts the notice period in these clauses realistically, because a fourteen-day participation window on a substantial raise is not a right that most individual shareholders can actually exercise.

Price-based anti-dilution protection is a separate mechanism that adjusts an investor's holding if a later round is priced below the round they invested in. The broad-based weighted average formula adjusts by reference to the size of the down round relative to the existing capital and is the market standard in Australia. The full ratchet reprices the entire earlier investment to the lower price and is aggressive enough that it can make a company difficult to raise into again, which is a point Lazarus Legal raises with founders presented with it in a term sheet.