Your Top 10 Questions on Shareholders’ Agreements Answered

By On Your Terms co-founder Natalie Fennell
Nov 2023

Shareholders’ agreements provide the clarity and protection business owners, founders, and investors need for working together. But they can be super complex, making them often daunting, time-consuming and expensive for small-mid businesses.

In this blog, we answer your most asked questions about shareholders’ agreements in simple terms to give you the knowledge to protect your interests and avoid unnecessary disputes with your business partners.

Q1: Is a shareholders’ agreement compulsory for all companies in New Zealand?

No, shareholders' agreements are not required by law in New Zealand. If you don't have a shareholders' agreement, your company will operate under the default rules in the NZ Companies Act 1993.

However, there are many reasons a shareholders’ agreement is super important (even for a small business, and even if the owners are friends or family). Let’s start with this one:

If you don’t have one (or this isn’t covered in your company’s constitution), a shareholder can sell their shares at any time, for any price, to anyone, including a competitor.

More generally, a shareholders’ agreement also helps prevent disputes, clarifies expectations, and provides a framework for growth and change within the business.

Q2: What’s the difference between a company constitution and a shareholders’ agreement?

A company constitution is a set of rules for how a company operates, while a shareholders' agreement focuses on how the shareholders (ie, owners of the company) interact and make decisions. The two documents work together, and most businesses should have both. By law, a company can only do certain things if its constitution (but not shareholders’ agreement) permits it.

A constitution is publicly accessible and must be filed with the New Zealand Companies Office. Whereas a shareholders’ agreement is a private document, so it can contain confidential or sensitive information.

Q3: What happens if one shareholder wants to leave the company and sell their shares?

Without a shareholders’ agreement (or constitution), a shareholder can sell their shares at any time, for any price, to anyone, including a competitor. Most business owners prefer control over who they are in business with to maintain the company’s stability and preserve its culture and values.

Most shareholders’ agreements create an obligation on a shareholder that wants to sell its shares to offer the shares to the other existing shareholders first, for an agreed price (or based on an agreed valuation formula or methodology – often ‘fair value’). If the other shareholders decline, the shares may then be offered to an outside buyer for the same or a higher price.

If the selling shareholder can only find a buyer offering a lower price, most shareholders’ agreements require the selling shareholder to re-offer the shares at that lower price to the existing shareholders. These rights over the shares held by other shareholders are known as ‘pre-emptive rights’.

Q4: Does a shareholders’ agreement include rules for bringing in a new shareholder?

It should! It can include a process for existing shareholders to approve or veto new shareholders, set pricing for new shares, or establish conditions for admitting new owners. It can also require the company to offer any new shares to the existing shareholders first (in proportion to their existing shareholding) before offering them to a new/outside shareholder.

When new shareholders join a company, they should be bound by the shareholders’ agreement before being issued shares. This is done by signing a Deed of Accession (or a Deed of Adherence).

Q5: What happens if a shareholder dies or becomes incapacitated?

A well-drafted shareholders' agreement should address what happens if a shareholder dies or becomes incapacitated. It may require the deceased shareholder's estate to transfer their shares to other shareholders at a pre-agreed price (or based on a pre-agreed formula).

Q6: What does ‘anti-dilution’ mean?

Anti-dilution provisions protect a shareholder from its shareholding percentage (the shares owned by a shareholder as a percentage of the total shares) being reduced when new shares are issued.

It can involve a requirement that any new shares are first offered to the existing shareholders (to preserve their shareholding percentage) before being offered to a new/outside shareholder. It can also involve the issue of ‘free’ shares to an investor if new shares are issued to new investors at a lower price than what the original investor paid (so that the early investor isn’t put in a worse position due to that later fundraising round).

Q7: What are ‘drag-along’ and ‘tag-along’ rights?

Tag-along rights allow minority shareholders to join in a sale of the company initiated by a majority shareholder(s), so benefit the minority shareholders. Drag-along rights require minority shareholders to participate in a sale arranged by the majority shareholder(s), so benefit the majority shareholders.

The specific terms of drag-along and tag-along rights can vary widely in shareholders’ agreements, such as the ownership threshold required to trigger the rights, and the timing and process for enacting the rights.

Q8: What happens if shareholders can’t agree on something?

A shareholders’ agreement should say what processes should be used to resolve disputes, such as mediation, arbitration, or appointing an independent expert to make the decision. They can also include a buy-sell provision that allows one shareholder (or a group of shareholders) to buy out the other’s shares in a deadlock. These options provide a quick, cost-effective and fair way to resolve conflicts without having to go to court.

Q9: What are ‘good leaver’ and ‘bad leaver’ provisions in a shareholders’ agreement?

Most shareholders’ agreements force shareholders to sell their shares either back to the company or to the other shareholders in certain circumstances.

Good leaver provisions provide a fair exit for shareholders who are forced to sell their shares under favourable circumstances, typically not due to their fault, for example, death or disability, redundancy or retirement. If a shareholder is a ‘good leaver’, they will receive reasonable value for their shares based on a pre-agreed formula, such as ‘fair value’.

A ‘bad leaver’ is a shareholder who is forced to sell their shares under unfavourable circumstances or for reasons not in the company’s or its shareholders’ best interests. Common examples are being dismissed as an employee for serious misconduct, competing with the company in breach of a non-compete obligation, failing to comply with an important term of the shareholders’ agreement, and in some cases, resigning as an employee (often within an agreed timeframe). A bad leaver must sell their shares to the other shareholders (or back to the company) at a discounted price.

Q10: What is founder vesting?

Founder vesting is where some (or all) of a founder’s shares do not become unconditionally owned until a certain period of time has passed, or certain milestones are met (after which the shares are ‘vested’).

If a founder stops being a shareholder or fails to meet the vesting conditions before these shares have vested, the founder’s shares are transferred back to the company.  The transfer price needs to be stated in a shareholders’ agreement – it could be fair value, a nominal price, the original share issue price or based on a formula.

This protects the interests of both founders (by ensuring all founders remain committed to the company’s success) and investors (by ensuring founders are financially incentivised to stay with the company and work towards its growth).

The reasonableness of founder vesting provisions will depend on the investment made by the founders in the company (money, IP and time) and should be carefully considered by both founders and investors.

Key points

A shareholders’ agreement is crucial for any company with multiple shareholders. It protects existing shareholders by setting rules for new shareholders joining, shareholders leaving, share sales and maintaining shareholding percentages. By having these rules and processes to follow if you have a dispute, you and your partners will save time and money as you navigate your business's ups and downs together.

The On Your Terms Shareholders’ Agreement has been prepared and peer-reviewed by expert lawyers with years of business law experience. With our user-friendly technology and helpful guidance and tips, you can craft a robust, legally binding agreement customised to your specific needs. If you need extra help or legal advice, we can connect you with our friendly business law firm partner for fixed-fee advice.

On Your Terms makes it faster, simpler and more affordable for New Zealand start-ups and small businesses to access top quality legal solutions and connect with legal experts.