Does Your Startup Need a Shareholders Agreement in Australia?

Most co-founders start a company on a handshake and a shared Google Doc. The constitution gets lodged with ASIC, the bank account gets opened, and everyone moves on to building the actual business. The problem is that a standard constitution was never written with your specific founding team in mind. It says almost nothing about what happens if one of you wants to leave, if you can't agree on a major decision, or if an investor wants to put money in next year. A shareholders agreement is the document that fills in those gaps, and it is worth getting right before you need it rather than after.

What this covers:

What a shareholders agreement does, and how it differs from your company's constitution
The clauses that matter most for a founding team, including exits, vesting and deadlock
What happens to your company if nobody ever puts one in place

What a shareholders agreement is

A shareholders agreement is a private contract between the shareholders of a company. It sits alongside the company's constitution rather than replacing it. The constitution is a public-facing document that sets out the basic rules for running the company: how meetings are called, how directors are appointed, how shares are issued. A shareholders agreement covers the same ground and more, but it is a private agreement between the people who hold the shares, and it can go into far more detail than a constitution typically would.

This distinction matters in practice. The constitution binds the company, its directors and all of its members through operation of law. A shareholders agreement only binds the people who sign it, which means a new shareholder joining later is not automatically caught by its terms unless they formally agree to be bound by it, usually through a short deed signed when they come on board. Most shareholders agreements also state that they prevail over the constitution if the two ever conflict, so the practical approach is to keep the constitution simple and put the detailed, founder-specific terms into the agreement instead.

Worth checking for: whether the constitution contains a matching clause pointing the other way. When only one of the two documents says which one wins, that gap is left for a court to resolve if a conflict ever comes up, so the safer approach is to keep both documents aligned from the start rather than leaning on one-sided wording.

Do you legally need one?

No. There is no requirement under Australian corporate law for a proprietary company to have a shareholders agreement. A company can be run entirely on its constitution and the default rules that apply automatically if the constitution is silent on a point. For a simple company with one owner, that is often perfectly fine.

For a startup with two or more co-founders, it is a different story. The more people who hold shares and have a say in decisions, the more likely it is that something will eventually need to be resolved that the constitution and the default rules simply don't address. A shareholders agreement is not a legal requirement, but for a multi-founder company it is close to standard practice, and most experienced investors will expect one to exist before they put money in.

Who gets a say: board composition and reserved matters

A shareholders agreement typically sets out how many directors each shareholder (or each class of shareholder) can appoint, so that board representation matches what the founders agreed to rather than defaulting to whatever the constitution happens to say. It will also usually list a set of reserved matters: decisions that need approval from a higher threshold of shareholders than an ordinary majority, sometimes unanimous approval from the founders.

Typical reserved matters include changing the nature of the business, raising new capital, taking on significant debt, selling a major asset, or entering into a related-party transaction. The point of a reserved matters list is to stop a majority shareholder from making a decision that materially affects a minority shareholder without that minority shareholder's agreement. For a founding team that starts out with equal or close-to-equal shareholdings, this is one of the more important protections in the whole document.

Keeping control of who owns your company

Shares in an Australian company are, by default, freely transferable to anyone. Most founders don't want that. A shareholders agreement typically restricts transfers so that shares cannot be sold to an outside party without first being offered to the existing shareholders. This is usually structured as either a right of first offer, where a selling shareholder must offer their shares to the others before looking outside, or a right of first refusal, where the selling shareholder can only sell to an outsider on terms no better than what the other shareholders were offered and declined.

These pre-emptive rights exist by default for proprietary companies under a set of standard rules that apply unless a constitution says otherwise, but the default version is fairly basic. Most shareholders agreements replace it with a more detailed process that sets out exact timeframes, valuation methods and notice requirements, so nobody is left guessing what happens when someone wants out.

Planning an exit: drag-along, tag-along and vesting

Two mechanisms do most of the work when a company is eventually sold. Drag-along rights let a majority shareholder (or a group holding above an agreed threshold) force the remaining minority shareholders to sell their shares on the same terms, so a buyer can acquire the whole company rather than being left with a minority stakeholder they never wanted. Tag-along rights work in the other direction, giving minority shareholders the right to join a sale on the same terms the majority shareholders negotiated, so they are not left holding shares in a company under new ownership they didn't choose.

A regulator recently examined drag-along and tag-along rights that had been inserted into a company's constitution rather than a shareholders agreement, and found that the mechanism needs to be properly disclosed and structured, since forcing a 100 per cent sale can otherwise brush up against the protections that apply to company takeovers. It is a reminder that these clauses need careful drafting wherever they sit, not just when they appear in a shareholders agreement.

Vesting schedules for founder shares are the other half of exit planning, and they protect the founders who stay rather than the ones who leave. A typical vesting arrangement ties a founder's full shareholding to an ongoing period of service, so that a co-founder who leaves after a few months does not walk away with the same equity stake as someone who stays for years. This is usually paired with good leaver and bad leaver provisions: a good leaver, someone who leaves for a legitimate reason such as ill health or by mutual agreement, generally keeps the right to sell their vested shares at fair value, while a bad leaver, someone who is terminated for cause or walks away in breach of their obligations, can be required to sell at a discount or at a nominal price. These provisions need to be based on objective, clearly defined criteria. A bad leaver clause that is really just a penalty for leaving, rather than a genuine response to misconduct, risks being challenged and struck down. Our guide on share vesting goes into more detail on how to structure a schedule that holds up.

What happens when co-founders disagree

Deadlock provisions matter most in companies with equal or near-equal shareholdings, which describes a lot of two-founder startups. A typical deadlock clause sets a process in motion once a genuine impasse is reached: usually starting with a formal notice, followed by a meeting between the parties to try to resolve things directly, and escalating to mediation or arbitration if that fails. Courts have been willing to enforce these processes and send the parties back to mediation or arbitration rather than letting a dispute go straight to litigation, provided the clause draws a sensible line between disputes over how the company is run day to day and a genuine question about whether the company should keep operating at all. The latter tends to remain a matter the courts will deal with directly, since no contractual process can force two deadlocked 50 per cent owners to keep working together indefinitely.

Dividends, confidentiality and non-compete obligations

Under the standard rules that apply by default, directors have discretion over whether and when to pay a dividend, and that discretion is wide. A shareholders agreement can set out a dividend policy that the founders agreed to, whether that's a commitment to distribute a share of profits each year or an understanding that profits will be reinvested in the business for the time being.

Confidentiality obligations are close to universal in shareholders agreements, restricting shareholders from disclosing or using the company's confidential information outside the business. Non-compete clauses go a step further and are common where the shareholders are also the people running the business day to day, since they are the ones with the clearest view of its strategy, customers and finances. These clauses are enforceable, but only to the extent they protect a genuine business interest and are reasonable in scope, duration and geographic reach. A non-compete that goes further than necessary to protect the business, rather than simply trying to punish someone for leaving, is at real risk of being unenforceable, and the courts apply this test more strictly where the person is really being restrained as an employee rather than as an investor.

What happens if you don't have one

Without a shareholders agreement, co-founders are left relying on the constitution, if one has been adopted, plus the default rules that fill any gaps. Those default rules cover the basics: appointing and removing directors, running meetings, voting, issuing shares, paying dividends and transferring shares. What they do not cover is almost everything a startup needs. There is no protection against a founder's shareholding being diluted beyond the basic pre-emptive right on new share issues, no mechanism for resolving a genuine deadlock beyond calling a general meeting, no vesting of founder shares, and no restriction on a departing founder immediately competing with the business or poaching its customers.

When something does go wrong without an agreement in place, the remaining options are limited and expensive: an oppression claim, where a shareholder argues the company's affairs are being run unfairly against their interests, or an application to wind the company up on the basis that the relationship between the shareholders has broken down entirely. Both are court processes, and both take considerably longer and cost considerably more than resolving the same dispute under a well-drafted agreement.

When founders get this done

In practice, three moments tend to prompt founders to finally put a shareholders agreement in place. The first is bringing on a new co-founder, when it makes sense to agree on equity split, roles, vesting and exit arrangements while everyone is still getting along. The second is raising external investment, since investors routinely require a comprehensive shareholders agreement as a condition of putting money in, often adding their own protections such as anti-dilution rights, information rights and board representation (our guide on seed funding covers what else to expect at this stage). The third is a founder deciding to exit, at which point the absence of an agreement creates genuine uncertainty about valuation, process and the rights of everyone who remains. The agreement is far more useful signed before any of these moments arrives than negotiated in the middle of one.

Common questions

Do I need a shareholders agreement if it's just me and one co-founder?
Generally yes. Two equal shareholders is the scenario where a deadlock mechanism matters most, since neither side has a natural majority to break a tie.

Can a shareholders agreement be put in place after the company is already incorporated?
Yes. It can be entered into or updated at any point all the current shareholders agree to it, including when a new investor or co-founder joins. It does not need to be done at incorporation, though it is generally easier to agree while less is at stake.

What happens to an existing shareholders agreement when a new shareholder comes on board?
Nothing automatically. A shareholders agreement only binds the people who sign it, so a new shareholder needs to sign a short deed agreeing to be bound by its terms before they are treated as covered by it.

Key takeaways

A shareholders agreement is a private contract between shareholders that works alongside the company's constitution, not instead of it, and most agreements say it should prevail if the two conflict
There is no legal requirement to have one, but for a startup with more than one founder it is close to standard practice, and investors will usually expect it
The clauses worth prioritising are transfer restrictions and pre-emptive rights, drag-along and tag-along rights, vesting with good leaver and bad leaver provisions, deadlock resolution, and reserved matters requiring a higher approval threshold
Without an agreement, co-founders are left with only the constitution and a set of generic default rules that offer little protection in the situations that come up in a startup
The best time to put one in place is when bringing on a co-founder, before raising external investment, or well before anyone is planning to leave

If you're setting up a company with co-founders, bringing someone new onto the cap table, or about to raise a round, Plumlaw can put together a shareholders agreement built around how your business works, on a fixed fee. Get in touch with Plumlaw to talk through what your agreement needs to cover.

This article is general information only and does not constitute legal advice. The law is complex and fact specific. What applies in one situation may not apply in yours. For advice specific to your circumstances, speak with a lawyer at Plumlaw.