If you’re starting a business with other shareholders a strong shareholder agreement is essential. Why? It not only governs rights, obligations, and protections for shareholders but also encourages smooth governance and avoids disputes down the road. A well-drafted shareholder’s agreement serves as a guide detailing what happens in different circumstances, such as the sale of shares, onboarding of new shareholders, or conflict resolution. We can think of it as the rule book to keep everyone on the same page!
In this ultimate guide, we’ll cover all aspects of shareholder agreements you need to know — from important legal clauses and the drafting process to best practices, FAQs, and sample templates. Whether you’re a startup founder or a corporate lawyer of decades, this article will provide you with all the knowledge you need to draft or check shareholder agreements with confidence.
What is a Shareholders’ Agreement?
A Shareholders’ Agreement is an essential governance document, that establishes consensus among all shareholders about how a company is managed and how critical decisions are made.
The main reasons that companies require a shareholders’ agreement are:
- Defined number of shareholders: Helps to address disputes related to Registrar of Companies (ROC).
- Defining roles: The agreement defines the roles, rights, and responsibilities of each shareholder.
- To ensure fairness: Protects minority shareholders from the will of the majority of shareholders.
A shareholders’ agreement, however, is a private document among the shareholders and does not need to be filed with the registrar of companies or made available to the public, unlike articles of association.
Who Is a Shareholder in a Company?
A shareholder is an individual or entity that owns shares in a company. Shareholders contribute capital to the company in exchange for ownership through shares.
Rights and responsibilities of the shareholders:
- Voting rights: Shareholders can vote on major company decisions.
- Dividend rights: A company’s profit is divided among shareholders.
- Rights to Information: Shareholders have access to financial and operational information of the company.
Shareholders can also be classified according to ownership percentage:
- Majority shareholders: They own control and own more than 50% of the shares.
- Minority shareholders: They hold less than 50% of the shares and often need protective provisions.
Types of Shareholders
Shareholders can be classified broadly into:
- Founders: Individuals who started the company and usually own a large amount of that company.
- Investors: Those who invest in your business in exchange for equity.
- Employee: Some companies issue shares to employees as part of an Employee Stock Option Plan (ESOP).
Leveraging expertise at the other end of shareholder qualification
- Regular shareholders: Hold common stock & voting rights.
- Preference shares: Have preferential rights over dividends but limited or no voting rights.
How to draft a shareholder agreement in India
When drafting a shareholder agreement, each clause needs to be anchored in the overall agreement and reflect both the spirit and the intent of the agreement. The following are the main steps in drafting a shareholder agreement:
- Identify Key Stakeholders: Prepare a list of all owners and how much stock they control.
- Identifying objectives: Set out the purpose of the agreement.
- Incorporate the necessary clauses: The critical provisions on ownership, voting, share transfers, and dispute resolution need to be addressed.
- Legal review: Get the draft reviewed by a suitable corporate lawyer.
- Approval and signing: All shareholders must approve and duly sign the agreement.
Purpose and Scope of a Shareholder Agreement
The main objective of the shareholder agreement is to:
- Control shareholder relations: Ensure clarity on roles, rights, and responsibilities.
- Outline governance guidelines: Explain how the company will be governed.
- Protect investments: Protect the interests of both majority and minority shareholders.
Shareholder agreements can vary but some of the most common clauses are decision-making, ownership structure, transfer of shares, and dispute resolution, among others, and their scope will depend on the size and nature of the business.
Legal Provisions in a Shareholder Agreement
1. Shareholding Structure and Who Owns
- States what percentage of shares each shareholder owns of the company.
- Sets out description of various kinds of shares, and what rights attach to them (e.g., ordinary shares vs. preference shares).
- Establishes thresholds for important decisions (e.g., 75% majority for key issues).
2. Rights and Responsibilities of Shareholders
- Specifies voting rights and unique benefits.
- Dividend distribution policies.
- To protect minority shareholders including ascertaining that unanimous consent is required for significant company decisions.
3. Share Transfer Restrictions
- Right of First Refusal (ROFR): Existing shareholders have the first opportunity to buy shares before they are offered to outsiders.
- Drag-along rights: Enable majority shareholders to compel minority shareholders to sell their shares in the event of a company sale.
- Tag-along rights: These rights protect minority shareholders, permitting them to sell their shares along with major shareholders.
4. Management and Governance
- Stipulates the process for appointing and removing directors.
- Describes reserved matters requiring shareholder approval.
- Outlines the roles and responsibilities of directors and senior executives.
5. Funding and Capital Contributions
- Establishes initial and ongoing capital contributions.
- Provides for consequences for shareholders not meeting capital contribution requirements.
6. Non-Compete and Confidentiality Clauses
- Protects business secrets.
- Prohibits shareholders from competing with the company’s business.
7. Dispute Resolution Mechanisms
- Contains clauses for mediation and arbitration if disputes arise.
- Indicate the jurisdiction and governing law for dispute resolution.
Common Mistakes in Drafting a Shareholder Agreement
- Neglecting to protect minority shareholders: Without protective provisions, controlling shareholders can abuse their power, leading to disputes over unfair treatment.
- Poor dispute resolution clauses: Without proper frameworks disputes can linger.
- Lack of clarity in share transfer restrictions: Vague clauses can cause confusion and legal disputes.
- A breach of confidentiality obligations: This can result in the leakage of sensitive data.
Sample Template of Shareholder Agreement
- Introduction: The introduction contains the names of the shareholders, the purpose of the agreement
- Ownership Structure: Percentage of shareholding.
- Governance: Guidelines for how directors are appointed and decisions are made.
- Transfer of Shares: ROFR, drag-along, and tag-along rights.
- Funding and Contributions: Capital commitments of shareholders
- Methodology: Methods of resolving conflicts
- Termination: New conditions in which the agreement can be terminated.
Examples of Disputes Between Shareholders and How Agreements Resolved Them.
Case Study 1: A start-up company consisting of three founders came to us with a problem. The ROFR clause in the shareholders agreement permitted the other founders the right to purchase the shares; thus, the ROFR served to deter unwanted entry by 3rd parties in the founder’s company.
Case Study 2: There was a difference of opinion over strategic decision-making in a joint venture. The clause on reserved matters within the shareholder agreement stipulated that unanimous consent was required from both parties for key decision-making, forcing both parties to negotiate and reach mutually beneficial terms.
Avoid This Mistake When Negotiating a Shareholder Agreement
- Align interests: Ensure that the terms of the agreement reflect the interests of both majority and minority shareholders.
- Get Legal Support: Utilize a corporate lawyer to create and evaluate the agreement.
- Be open: During negotiations, articulate expectations and potential risks.
- Incorporate flexibility: Review, and amend periodically as the business evolves.
Provisions in Law for Minority Shareholders
Minority shareholders frequently live in fear of being steamrolled by majority shareholders. To avoid such situations, certain safeguards exist within Indian corporate law as below:
- Oppression and Mismanagement: If a minority shareholder feels that they are being treated unfairly by the company, they can approach the National Company Law Tribunal (NCLT), by provisions under the Companies Act.
- Pre-emptive rights: Gives minority shareholders the right to buy additional shares to keep their ownership percentage the same when new shares are issued.
Review and Update of Shareholder Agreements
A shareholders’ agreement should be periodically reviewed to keep it relevant. Material triggers include:
- Change in the structure of ownership: New shareholders coming in or existing shareholders exiting.
- Changes in your business: New markets or business lines could lead to amendments.
- Regulatory changes: Changes to corporate law may require updates.
An amendment of this charter shall require the consent of all shareholders and shall be evidenced by writing.
FAQ: Top Shareholder Agreement Questions Answered
1. Is a shareholder agreement legally binding?
Yes, the shareholder agreement is legally binding when signed by all parties. This spells out rights and obligations that are enforceable against shareholders to a certain extent.
2. How do you write a shareholder agreement?
- Defined ownership structure and voting rights
- Incorporate important provisions regarding share transfer, governance structure, funding obligations, and dispute resolution mechanisms.
- Make sure you observe local laws and more.
- Get a qualified corporate lawyer to review the draft.
3. Who needs a shareholder’s agreement?
Shareholder agreement should be in place for any company with multiple shareholders. It’s especially important for companies that are startups, joint ventures and have third-party investors to mitigate the risk of a conflict.
4. Who accepts a shareholder agreement?
The shareholder agreement should be signed by all shareholders of the company. This refers to both existing and any newly onboarded shareholders (all new future investors) as stated in the agreement.
5. Who cannot be a shareholder?
In general, anyone can be a shareholder unless prohibited by statute or by a company.
Conclusion
One of the key steps in incorporating your business is to draft a shareholder agreement which is a decision between shareholders that is a lot more than just a formality but instead is important in governing the relationship between shareholders and protecting their interests. By addressing the importance discussed above, you can mitigate any unnecessary disputes, and ensure smooth the operation of the company. Whether you’re drafting an agreement from scratch or reviewing an existing one, if you pay close attention to these provisions, your business will be protected in the long run.
Preparing to draft your shareholder agreement? Contact a corporate lawyer for assistance if you are unsure whether your document is legally binding or meets your specific needs!
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