An Overview to Investing in a Company
For companies to develop and grow, it is critical that there is access to funding or capital. The owners of companies may ask family members and friends to invest in the company. If you are in this position and considering investing in your friend or family members company and if you have satisfied yourself that the company is commercially viable, you should be aware of what your rights and obligations are as a shareholder. This article covers some of the considerations you may not be aware of.
Subscribing for Shares
When a new shareholder is introduced to a company, they are not sold or transferred existing shares. Rather, the company will issue new shares for the new investor. In this way, the investor will be subscribing, or in other words, registering to receive the shares. That way your investment goes into the company. If you buy shares from a shareholder then the shareholder, gets the money not the company.
- If a shareholder owns 200 shares, they will not sell or transfer 100 shares to the incoming investor so that there is a 50:50 ownership split.
- Rather the company will issue another 200 shares to the new shareholder, so there will be 400 shares in total, The new investor and old shareholder will each own 50% of the company.
- The new shareholder pays the company for the 200 shares.
It is important to be aware of the financial risks that may be associated with subscribing to shares. For example, if the company performs poorly over a period, it is likely that the value of your shares will reduce, and you may not be able to sell them at the price at which you purchased them.
What Does Being a Shareholder Entail?
If you are a shareholder, you hold partial ownership of the company. If the company is doing well financially and making profits, it will typically use the profits:
- To reinvest in the company; and
- Use some of those profits to pay money (dividends) to its shareholders.
The Difference Between being a shareholder and lending to a company
If have lent money to a company, this is different to being a shareholder, as you will not receive shares. You will have a loan agreement, which will set out the interest rate for the loan and when the company will repay you. If the company does not repay you have rights against the company to recover your loan.
When you invest in the company and become a shareholder, you will receive shares. The value of the shares can increase or decrease depending on how the company is performing financially. However, unless you sell your shares you cannot recover the money you invested, except in certain special circumstances like fraud.
Subject to the conditions outlined in the Shareholder’s Agreement, you may have the option of selling your shares to other shareholders in the company or to third parties. You may be able to sell your shares for a higher price than what you initially bought them for if the company has been financially successful, as the value of the shares will have also increased.
Rights of Shareholders
Your rights as a shareholder are governed by:
- Corporations Act 2001 (Cth) the company constitution; and
- The Shareholders’ Agreement.
You should request a copy of these documents for your personal records and also to further understand your rights.
Shareholder Rights under the Corporations Act
Some important rights are:
- Rights to vote on certain matters;
- Right to participate in corporate decisions, such as issuing shares;
Right to sue the company to force it to act lawfully;
What the Shareholders Agreement will set out
We always recommend that there is a Shareholders Agreement, this is a key document that is created to outline what are the rights and obligations of shareholders. Some of the things that this document may contain include:
- Who has the right to vote on certain corporate matters – for example, which decisions will be made by directors and which decisions will be made by shareholders;
- Who has the right to appoint directors of the company;
- The process for selling shares.
What are the Steps to Subscribing for Shares?
1. Preparing and Signing a Subscription Agreement
Typically, a company will prepare a Share Subscription Agreement for new shareholders, which the shareholder must sign. This document will include several formal details such as:
- The number of shares that you are a subscribing for;
- The price of the shares;
- A clause seeking your agreement to be a member of the company and be bound by the company’s governing documents; and
Additionally, Share Subscription Agreements may also include guarantees for incoming investors that may make them feel more secure about purchasing shares in the company. This includes:
- A guarantee that the information provided by the company is true and accurate;
- A guarantee that the company owns all the relevant licences and intellectual property; and
- A guarantee that the company is not facing impending litigation.
If any of the terms of the Share Subscription Agreement are breached by the company, then you may be able to take legal action against them.
2. The Company Takes Steps to Issue Shares
Once the above steps have been taken, the company will take administrative and legal steps to issue shares to the shareholders. This includes:
- Holding shareholder/board meetings to approve the issuing of shares;
- Providing share certificates to each incoming shareholder;
- Updating the company register of shares to reflect the new changes;
- Updating the Australian Securities and Investments Commission’s (ASIC) Register
- Insist on a shareholders’ agreement.
- Before subscribing for shares, you should carefully weigh up both the benefits and risks.
- It may be advisable to seek legal and financial advice on what your rights and obligations will be if you choose to invest in a company and become a shareholder.
If you are planning to invest in a company and require further advice, we can help. You can contact Lord Commercial Lawyers on 9600 0162, email us at firstname.lastname@example.org, or fill out the form on this page.
Lord Commercial Lawyers is a commercial and business-focused law firm based in the Melbourne CBD. We work with businesses and individuals to help them achieve their legal and commercial goals