Purchasing a Minority Shareholding in a Company: A Practical Guide

Introduction

Shares in companies are issued and sold for a variety of reasons: whether it is a small business owner selling some of their shares to bring in a new business partner, or a company desiring to raise capital. In many cases, an incoming shareholder would purchase a minority share in the company. However, if a dispute ever arises in the future, a minority shareholder may realise that they don't have much control over the decision-making of the company.

Key Documents

When purchasing shares, there are two key documents in addition to the Company Constitution that will shape your relationship with the company and the other shareholders:

1. A Share Sale Agreement; and
2. A Shareholders Agreement

The Share Sale Agreement may outline key terms and conditions of purchasing the shares, such as:

1. The number of shares being purchased;
2. The price to be paid for the shares;
3. Warranties from the seller regarding the company's financial position and other matters;
4. The due diligence to be completed by the purchaser before the sale is completed.

However, it does not outline how the relationship between the shareholders will be governed or how the company would be managed once you have purchased the shares.

As a majority shareholder would own a larger proportion of the shares, it is natural that they will have more control and power over the company. However, if you would like to influence the manner in which the company is governed, it is crucial to enter a Shareholders Agreement which clearly outlines what each shareholder can and cannot do, among other things.

Below, we highlight some of the key terms that you should consider including in a Shareholders Agreement as a minority shareholder:

Veto Rights

Generally, minority shareholders have a limited say under the Company Constitution and the Corporations Act 2001 (Cth), but if there are certain important decisions that you would like to influence, it would be essential to include a right of veto in relation to those decisions, which may include:

1. Issuing new shares (so as not to dilute your existing shareholding);
2. Making amendments to the Company Constitution;
3. Selling or changing the business; and/or
4. Changing the remuneration of directors and/or senior employees (e.g., so that a majority shareholder, who is also a director, cannot increase their salary unilaterally).

The right of veto would usually be achieved by ensuring that these kinds of decisions require unanimous shareholder approval.

Control over the Directors

It is common knowledge that the day-to-day operations of a company are managed by the directors and not by shareholders. Therefore, if you want to have greater control over the operations of the business, you might want to consider requiring a right to appoint a representative director to the board of the company.  

Usually, majority shareholders prefer to retain this right for themselves, but there can be some circumstances (e.g., when the minority shareholder is being brought into oversee the operation of the company because of their specific expertise) when it can be easier to negotiate to obtain this right.  

Right of First Refusal

A right of first refusal (also known as preemptive rights) ensures that if a majority shareholder ever chooses to sell their shares to a third party, the remaining shareholders must be offered the option to purchase those shares first. This ensures that you would not have to adjust to a new shareholder (with whom you may or may not be able to develop a good working relationship); and be able to own a greater proportion of the company if you wish to do so.  

Tag-Along Rights

A related preemptive right is a tag-along right, which allows a minority shareholder to 'tag' along with a majority shareholder if they choose to sell their shares to a third party. This avoids the possibility of you being left behind if the majority shareholder wants to exit the company.

Selling Minority Shares

The Shareholders Agreement should also include the process for selling your shares back to the company or the majority shareholder if you decide to leave. This would usually involve setting out a method of valuing the shares (such as appointment of an independent valuer) so that no dispute arises when you are exiting the company.

Dispute Resolution

Finally, a Shareholders Agreement should also include dispute resolution mechanisms which can play a crucial role in ensuring smooth operations and fair resolution of conflicts within the company. Incorporating dispute resolution methods such as mediation provides a structured approach to address disagreements, minimising disruptions to business activities.

How Sharrock Pitman Legal can help

A well-drafted Shareholders Agreement can be a powerful tool for minority shareholders to protect their interests and delineate their relationship within the company and with other shareholders. By taking proactive measures when entering into a Shareholders Agreement, minority shareholders can not only safeguard their position, but can ultimately foster effective corporate governance and ensure a balanced environment for all shareholders involved.

If you require advice regarding an existing Shareholders Agreement or assistance drafting a Shareholders Agreement, please do not hesitate to contact our Commercial Law team on 1300 205 506 or sp@sharrockpitman.com.au.

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The information contained in this article is intended to be of a general nature only and should not be relied upon as legal advice. Any legal matters should be discussed specifically with one of our lawyers.

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