Most Australian startups incorporate a company and move on. Maybe the founders shake hands, split equity, and start building. If they’re diligent, they adopt a company constitution. If they’re more diligent still, they sign a shareholders’ agreement. But very few founders understand what each document actually does — or why having only one of them leaves significant gaps.
A company constitution and a shareholders’ agreement serve different legal functions, operate under different legal frameworks, and protect different interests. They overlap in places, but they are not interchangeable. Here’s what each does, where they differ, and why a properly structured startup needs both.
The Company Constitution: Your Corporate Rulebook
A company constitution is the internal governance document for a proprietary company registered under the Corporations Act 2001 (Cth). Under section 136, a company may adopt a constitution before or after registration. If a company doesn’t adopt one, it is governed by the “replaceable rules” — a set of default provisions scattered across Part 2F.1 of the Act.
The constitution operates as a statutory contract under section 140 of the Corporations Act. It binds the company, its directors, its company secretary, and its members (shareholders) to observe and perform its provisions as if they had each covenanted to do so. This is an important legal concept: the constitution doesn’t just bind the people who signed it. It binds anyone who becomes a member of the company, including future shareholders who had no say in drafting it.
What a constitution typically covers:
- How shares are issued, transferred, and (in some cases) forfeited
- The rights attaching to different classes of shares (ordinary, preference, etc.)
- How directors are appointed, removed, and remunerated
- Procedures for board meetings and general meetings, including quorum and voting
- The powers of directors to manage the company’s business
- Dividend declarations and distribution mechanics
- Procedures for winding up the company
The constitution is a corporate mechanics document. It tells you how the company operates — not how the shareholders relate to each other or what happens when things go wrong between them.
Key characteristic: A constitution can modify or replace the replaceable rules under the Corporations Act, but it cannot override the Act’s mandatory provisions. It is also a quasi-public document — while it isn’t filed with ASIC in the way a public company’s constitution might be scrutinised, any member is entitled to inspect it, and it can be required to be produced in legal proceedings.
The Shareholders’ Agreement: Your Relationship Contract
A shareholders’ agreement is a private contract between the shareholders of a company (and usually the company itself as a party). Unlike the constitution, it is not governed by section 140 of the Corporations Act. It is governed by ordinary contract law — the same principles that apply to any commercial agreement.
This distinction matters. Because a shareholders’ agreement is an ordinary contract, it can include terms that would be difficult or impossible to include in a constitution. It can address commercially sensitive arrangements, impose personal obligations on shareholders, and deal with scenarios that the Corporations Act was never designed to cover.
What a shareholders’ agreement typically covers:
- Decision-making thresholds — matters requiring board approval, shareholder supermajority consent, or unanimous agreement
- Pre-emptive rights — the right of existing shareholders to participate in new share issues before outsiders
- Share transfer restrictions — right of first refusal, tag-along (co-sale) rights, and drag-along rights
- Vesting and leaver provisions — what happens to a founder’s shares if they leave the company, voluntarily or otherwise
- Non-compete and non-solicitation clauses — restraints on shareholders competing with the company
- Dividend policy — agreed rules about when and how profits are distributed
- Deadlock resolution — what happens when the board or shareholders can’t agree on a critical decision
- Exit mechanisms — how and when shareholders can sell their shares, including put and call options
- Confidentiality — obligations not to disclose the company’s commercially sensitive information
- Intellectual property — confirmation that IP created for the company belongs to the company
Key characteristic: A shareholders’ agreement is confidential. Unlike the constitution, it is not available for inspection by third parties. This makes it the appropriate place for commercially sensitive terms — vesting schedules, founder salary arrangements, non-compete obligations, and exit pricing mechanisms — that the parties don’t want exposed.
Why You Can’t Just Pick One
Founders often ask: “If I have a shareholders’ agreement, do I still need a constitution?” The answer is yes, and here’s why.
1. They Operate Under Different Legal Frameworks
The constitution is a statutory contract under section 140. It binds all members — present and future — by operation of law. A shareholders’ agreement only binds its signatories. If a new investor takes shares in the company and doesn’t sign a deed of accession to the shareholders’ agreement, they are not bound by it. They are, however, automatically bound by the constitution.
This means certain protections must sit in the constitution to be effective against all members. Share class rights — the specific rights attaching to preference shares, for example — need to be defined in the constitution to have full statutory force. An investor relying solely on a shareholders’ agreement for their preference rights is taking an unnecessary risk.
2. A Shareholders’ Agreement Cannot Override Replaceable Rules
This is a subtlety that catches many founders off guard. The replaceable rules in the Corporations Act apply unless displaced by a company’s constitution (section 135). A shareholders’ agreement, because it is not a constitution, does not displace the replaceable rules as a matter of statute.
In practice, this means you could have a shareholders’ agreement that says one thing and a replaceable rule that says another — and acting in accordance with the shareholders’ agreement might technically breach the Corporations Act. The solution is simple: adopt a constitution that displaces the replaceable rules and aligns with your shareholders’ agreement.
3. They Protect Different Interests
The constitution protects the company’s governance framework. It ensures that the mechanics of running the company — issuing shares, holding meetings, appointing directors — follow agreed procedures. It operates for the benefit of the company and all its members as a class.
The shareholders’ agreement protects the commercial deal between specific people. It addresses what happens when a co-founder wants to leave, when shareholders disagree, or when someone wants to sell. These are relationship issues, not corporate mechanics issues, and they belong in a contract between the parties — not in the company’s constitutional document.
4. Confidentiality
Commercially sensitive terms belong in the shareholders’ agreement because it is a confidential document. Vesting schedules, salary arrangements, non-compete terms, and exit pricing are not matters that should be visible to every future member of the company or discoverable in litigation without specific disclosure obligations.
When They Conflict: The Precedence Question
Well-drafted documents will include a precedence clause that specifies which document prevails in the event of a conflict. Most shareholders’ agreements state that the shareholders’ agreement prevails over the constitution as between the parties. This is important — as between the signatories to the shareholders’ agreement, the shareholders’ agreement takes priority. But against a third party who is bound by the constitution but not the shareholders’ agreement, the constitution governs.
This is exactly why the two documents need to be drafted together. When the constitution says one thing about share transfers and the shareholders’ agreement says something slightly different, you create ambiguity — and ambiguity in corporate governance documents tends to surface at exactly the wrong moment, usually during a dispute or an exit.
Australian courts have grappled with this tension. The prudent approach is to ensure the two documents are consistent on all overlapping matters, clearly delineate which document governs which subject matter, and include a properly drafted precedence clause.
A Practical Framework for Startups
If you’re an early-stage founder, here’s a practical way to think about what goes where:
In the constitution:
- Share class rights and variation procedures
- Director appointment and removal mechanics
- Meeting procedures (board and general meetings)
- Share issue and transfer mechanics (basic framework)
- Winding up provisions
- Displacement of the replaceable rules
In the shareholders’ agreement:
- Founder vesting and leaver provisions
- Detailed share transfer restrictions (ROFR, tag-along, drag-along)
- Pre-emptive rights on new issues
- Reserved matters requiring shareholder consent
- Non-compete and confidentiality obligations
- Deadlock resolution mechanisms
- Dividend policy
- IP assignment confirmations
- Exit mechanisms and valuation methodology
In both (consistently):
- Share transfer restrictions should be reflected in the constitution at a high level (e.g., “shares may not be transferred except in accordance with this constitution and any shareholders’ agreement”) and detailed in the shareholders’ agreement
- Pre-emptive rights on new share issues may appear in both, but the detailed mechanics should be in the shareholders’ agreement
Don’t Wait for a Dispute
The most common time founders discover they need a shareholders’ agreement is when they’re already in a dispute — a co-founder wants to leave, a minority shareholder is blocking a decision, or an investor is asking why there’s no governance framework in place. By then, it’s too late to negotiate fair terms. The leverage has already shifted.
Similarly, startups that rely on the replaceable rules instead of adopting a constitution discover their limitations when they try to issue preference shares to an investor, or when a departing director disputes the process for their removal.
Both documents are cheaper and easier to put in place when everyone is aligned and optimistic. That’s the time to do it — not when the relationship is already strained.
If you’re setting up a new company or preparing for a fundraise and need to get your governance documents in order, get in touch. We draft both documents as a coordinated pair, ensuring they work together rather than against each other.
