A Shareholders Agreement (SHA) is nothing but an agreement laying down the understanding between the shareholders of a company and forming the cornerstone of the shareholder-company relationship.
A shareholder is an individual or a legal entity that is a participant in a company (both private and public company) and who holds a certain part of the share capital.
It contains the different terms on which a company must protect the rights of the shareholder while maintaining its revenue-generating business. As a shareholder you will have your own vested interests; therefore, they must be drafted keeping in mind your concerns while protecting the business interests. All investors, whether full-time or not, are motivated to protect and grow their investments to the maximum. And they do it with the help of a well-drafted SHA.
The SHA is also used to ensure that the shareholders are actively participating in the affairs of the company. In case any shareholder does not want further involvement in operating the company, the SHA can mandate to sell his/her shares back to the company or remaining shareholders.
A well-drafted SHA will safeguard the investor's money from being misused, keep opportunism by promoters under check and determine the exit mechanism and methods for maximizing the profits.
You should not confuse a Shareholders Agreement with that of the bylaws of the company. The bylaws of the company including the Articles of Association and Memorandum of the association were created shortly after the creation of the company.
The bylaws are obligatory for all companies and have to be filed with the Registrar of the Companies concerned. The bylaws are applicable to all the personnel and entities connected with the company. On the other hand, the SHA is a matter of choice between the shareholders of the Company and only binds the signatories to the SHA.
The bylaws exist as long as the Company exists. The term and termination of the SHA can be decided mutually between the Parties signing the SHA.
The bylaws are a single constitutional agreement and there can be multiple SHA's as per the situation and structure of the company. Usually, the SHA supplements the bylaws by adding mutually agreed terms between the shareholders.
The company's bylaws set the rules and regulations for operating the company. On the other hand, a Shareholders Agreement is created to set certain rights and obligations among the shareholders of the company.
The bylaws of the company are generally available for public inspection, whereas the terms of an SHA usually are confidential between the parties.
An SHA usually is entered into between the existing investor(s)/promoters/founders and a new investor. In an SHA, you will find that all the shareholders, except ESOP (Employee Stock Ownership Plan) holders, will be joined as a party to the contract.
Although it is not necessary for a company to be a party to the SHA, it is always advised to include the company as a party to an SHA; because if and when a dispute arises between the company and shareholders, contractual remedies including in share transfer, the appointment of board members, the amalgamation of company, important decisions, etc.
An SHA is entered into as a natural consequence of an investment or a prospective investment (future investment). The following are some of the investment factors to be considered while drafting an SHA:
The share transfer is the process of transferring the existing shares from one person to another individual or entity through sale or by way of gift. The conditions and restrictions on share transfer by shareholders including the following must be considered:
For example, company ABC Pvt. Ltd is planning to issue new shares to raise capital by issuing 10,000 shares. in such a case, the existing shareholders will have the right to purchase whole 10,000 shares before they are given to outsiders. If the existing shareholders have purchased only 8,000 shares, then the remaining shares will be sold to outsiders.
For example, in company "A" holds 70% of the ownership, and he desires that whenever he intends to sell his stake in the company the remaining 30% of shareholders will be obligated to sell along with him at the same price.
For example, in a company ABC Pvt. Ltd. A and B hold 80% of the ownership and C holds 20% ownership. Suppose if A and B decide to sell their stake in the company, C will have the right to sell his share of 20% at the same rate.
The share transfer clause is introduced to protect the rights of both the investors and the company in the long run.
Most investors, motivated by their confidence in the promoter, invest money into the company. One-way investors ensure promoters stick to the company is by introducing the founder lock-in-clauses.
A lock-in clause is inserted to prevent the investor or any other party from leaving the company or selling off the stake in the company for a certain period or without meeting certain conditions. The lock-in-clauses ensures, the continued active participation of the founders throughout the journey of the company. This protects the investors from situation where the founding members leave the company after getting enough funding and without completing the project or goal of the company.
Depending on the context of entering into an SHA, and the commercial interests of the investors, an SHA could contain the following:
These provisions allow the existing shareholders to increase their shareholding while restricting the entry of new shareholders. Apart from this, these provisions also address existing investors' liquidity concerns.
The vesting of managerial rights to shareholders is one of the main reasons why investors are keen to allocate their money to a company. In an SHA, the following points must be touched upon with regard to the rights of management:
There are several ways investors use to obtain and maintain their participation in the company's management. One method is to appoint a nominee of the investors on board. Another method is quorum requirements mandating the presence of the nominee director, along with voting rights, and veto rights in certain matters make them a spokesperson for the investor in the Board of Directors.
Certain SHAs may also prescribe the appointment of a board observer, to track the company business and participate in meetings without having the right to vote.
The SHA may place a contractual obligation on the shareholders not to communicate or use any information relating to the business, affairs, customers, clients, or suppliers of the company.
When drafting this clause, it is essential to carefully define what constitutes "confidential information" and in what circumstances the disclosure of such confidential information is permissible.
If required a detailed Non-Disclosure Agreement (NDA) can be signed and attached along with the Shareholders Agreement.
The SHA will cover the provisions to protect the competitive interests of the company including:
The exit clause lays down the specifics for an investor exiting a company such as the time when an investor can exit and the consequences of failure by promoters to give an exit strategy to investors.
A liquidation event in SHA clearly defines such scenarios and the liquidation preference rights of the investors. In preference, the investors will receive the amount of investment along with the predetermined percentage of proceeds.
An SHA accomplishes its goal of preserving the shareholder's interests by granting them special rights in addition to those granted to them by the Companies Act, 2013. A properly drafted SHA helps the investors with unexpected events that may take place throughout the company's operations. An SHA enhances the confidence of investors and the company in return receives long-term support from such investors.