Starting a company with others is an exciting venture, but before any operations start, it is essential to have a corporate constitution. A constitution outlines the internal management of your company, meaning that each constitution can look different for each company. In this article, we go over some key things in a company constitution and why it’s crucial to tailor it to your business when starting a company with others.
What is a Constitution?
A constitution, also known as a corporate constitution or company constitution, lays out the rights and obligations of each of those parties to each other. These include:
- Powers of directors and shareholders;
- How directors and shareholders are appointed, replaced, or removed; and
- How meetings, shares and dividends work.
Unlike normal contracts, where a person usually signs it to be bound by it, anybody that becomes a director, secretary, or shareholder of a company will be bound by its constitution, even if they aren’t aware of it. Changing the constitution is also different to normal contracts, in that you will need a special resolution to make any changes to it. This means that you need 75% of your shareholders to vote in favour of the change, as opposed to an ordinary resolution, which is just 50%.
What are the Replaceable Rules?
The Corporations Act 2001 (Cth) outlines a ‘default constitution’ for companies, which you can displace or modify in your corporate constitution. These are called the ‘Replaceable Rules’.
It’s best to speak to a lawyer in order to tailor your constitution to your business, despite the Replaceable Rules being available. While it can be tempting to just use the Replaceable Rules, these can leave massive loopholes in the processes of your company.
For example, the Replaceable Rules allow shareholders to remove a director by ordinary resolution and appoint a replacement in the same way. A company’s constitution, however, can modify this position, for instance, by requiring a higher approval threshold (such as a special resolution) or imposing additional conditions for the removal and appointment of directors.
If you’re both the only director and the only shareholder of your company, then there is a different, shorter set of rules that apply, and these are not replaceable by the constitution. These provisions are mostly to do with conferring your power over the company decisions, what happens if you’re unable to continue as sole director/shareholder, and how resolutions work as a 1-shareholder company.
What should be covered in your Constitution?
So, what should you include or cover in your constitution? Of course, it depends on your business’s needs and future plans. Below are some general matters to consider including in your constitution, however it is not an exhaustive list.
Board of the Company
A board of directors are the people that run daily operations of the company, whereas shareholders are the people that own and fund the company. As a small business owner using a company business structure, it’s completely normal to fill both roles.
However, no matter the current size of your business, your constitution should include what the board of the company looks like and what the process is for adding and removing directors, especially if you’re expecting rapid growth in your business.
Considerations for directors in your constitution include, but are not limited to:
- Powers of the directors;
- Resignation;
- Retirement;
- Procedures for breach of provisions from your company’s constitution;
- Invalid appointment;
- Appointment of managing directors where there is a vacancy; and
- Procedures on death of a director.
Shareholders
As said before, shareholders are the people that own and fund the company. Four important things to think about regarding members in your constitution is how transferral of existing shares work, how the company can issue new shares, and how you might pay dividends.
Transferral of Shares
Under the Replaceable Rules, transfers of shares can take place voluntarily, on bankruptcy, on death, and on mental incapacity. For proprietary companies (which are most companies in Australia), directors can refuse registration of transfers, blocking the transfer from happening.
With your constitution, you might think about whether you want to:
- Change what happens on bankruptcy, death or mental incapacity of a shareholder
- Impose a procedure for directors refusing to register transfers of shares
These provisions are important for controlling who owns and gets a say in your company.
Issue of Shares
Issuing shares is how companies gather more funds. It’s like selling a portion of the authority within the company. Under the Replaceable Rules, for proprietary companies, if you issue new shares, they must be offered to existing shareholders first. This is because it helps prevent dilution of the existing shareholders’ power over the company.
With your constitution, you might think about whether you want to change this ‘pre-emption’ rule, or whether certain shareholders should get first pre-emption rights.
Dividends
When a company has paid its expenses, it can choose to pay the remaining revenue to shareholders through dividends. Under the Replaceable Rules, directors have full discretion to decide how much is paid in dividends, when, or whether to pay dividends at all.
With your constitution, you might think about:
- Do you want to mandate a proportion of remaining revenue to be paid as dividends?
- What else could you be using the revenue for? It could be used for paying the directors, employees, or reinvesting back into the business.
What Next?
When starting up your company, a corporate constitution is crucial in protecting the way you want to run your business.
An experienced lawyer can help you navigate the confusing relationship between the company, directors, and shareholders. We can help you set up a clear and comprehensive constitution that will support your business’ growth in the future.
For help with your corporate constitution and building your business, contact us for a free, no-obligation chat.
