Important Clauses in a Shareholders’ Agreement

Last Updated at: Oct 12, 2020
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In business, it’s best that nothing goes undocumented. When you and your partners contribute money or effort in return for equity, this, too, needs to be documented. It is usually done in a Shareholder’s Agreement, which will declare the exact ownership stake of each partner in addition to their obligations. It will also ensure that directors need to follow a process while transferring shares, may give special rights to some shareholders, require that the board have a certain composition and place financing requirements on members.

There is no set requirement of a shareholders’ agreement and the courts often frown upon those clauses that are not consistent with the Companies Act, 2013 and the Articles of Association framed by the company, particularly those that curtail the rights of shareholders. If you do consider getting a shareholders’ agreement, ensure that your lawyer has a good handle on both. Let’s examine what needs to be included in a Shareholders’ Agreement:

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Clauses in a Shareholders’ Agreement

Obligations of Shareholders: All those party to the agreement will have their roles and obligations well-defined. The composition of the board may also be stated here. The relationship between minority and majority shareholders as well as the board and other shareholders must also be monitored.

Restriction on Transfer: Through this agreement, some restrictions may be set on the transfer of shares. Right of first refusal and right of first offer are two common clauses. There may also some clauses forcing transfer through tag- and drag-along rights. Buy-back rights may also be defined here.

Special Rights: If you’re desperate for money from a VC, surely expect him to place himself on a higher plane. This may be through additional seats on the board, preferential rights and much else.

Warranties: Investors will want to know that all the assets and liabilities of the company have been disclosed to them. On account of this, the directors will usually grant warranties to investors up to a specified amount.

Vesting Periods: The agreement will state what happens to the shares if a director needs to leave, the vesting period for each shareholder and when they are deemed to have been offered for sale to the company and other shareholders.

Difficult Questions: You may never expect it to, but all sorts of terrible things can happen to a company. Some shareholders may want to leave, a bank may pull funding and some documents may have found not to have been in order. The consequences of each of these can be discussed in this agreement.

Advantages of a Shareholders’ Agreement

Start-ups run a very high risk of falling apart at any moment. For this reason, entrepreneurs are always under pressure, which can lead to poor communication. To manage such a situation, a shareholders’ agreement is crucial as it ensures that such matters are handled properly. Often, such an agreement is neglected, as it brings up too many awkward conversations. However, its absence could have graver consequences in times of disagreement, disappointment and clashes among the shareholders.

Advantages of a Shareholder’s Agreement

The followings are reasons for a shareholder’s agreement:

The Small Guys: A company is not run by equal shareholders. There are majority and minority shareholders. While preparing a shareholders’ agreement minority shareholders should specify their role in the company. They must ensure they have a say during making any important decision. The decision may be about new partners or removing a person from the board of directors.

Parallel Worlds: Any shareholder with less than 50% of the shares is considered a minority shareholder. But owning a smaller amount of shares should not deprive him from access to the company. For example, there may be a tag along clause, which ensures that if a majority shareholder is selling off his shares, the minority shareholders should be able to get the same deal.

Gaining Control: A company is run on the basis of company laws which are directed by the responsible comprehensive body. Shareholders are not officially given any rights to interfere with such existent laws. Introduction of documents like shareholder’s agreement will ensure that they can have a legal association with the company. But this may not be possible without having such formal document.

Protecting the Position: The signing of the shareholders’ agreement ensure the shareholders are protected. While the Articles of Association do provide certain protections, they are not as specific as a shareholders’ agreement.

The Board Game: Managerial and administrative decisions of a company are mostly determined by the board of directors. Shareholders are informed only about very important decisions. There should be restrictions on the matters that can be decided by the board and these can be included in this agreement.

The Key to Stability: While the Articles of Association are made public, a shareholder’s agreement is private. This is a rock solid way to prevent disputes among the management.