Shareholders Agreement
We all are aware that a ‘Share’ is a share in the ‘Share Capital’ of a Company, and a Shareholder is a person who has subscribed to such Share of a Company.
When a group of people come together and start a company, they orally decide on their respective contributions towards Share Capital and their set of duties. Based on their oral terms, the Articles of Association (hereinafter referred to as ‘Articles’) of the company is drafted. Generally the Articles of a company covers high level terms with regards to the mode of Capital and Shares, Mode of Share Transfer, Directors rights and duties, Meetings, Proceedings of the Board, and other operational terms. These terms in the Articles may not be drafted in detail.
Further, few of the Investors these days enter into another written understanding called as ‘Shareholders Agreement’ (hereinafter referred to as ‘SHA’) in addition to Articles of the Company. SHA can be defined as an arrangement among the Company’s Shareholders describing how the company should be operated and what are the Shareholders’ rights and obligations.
If a Company is formed among st your family or well known friends, there need not be any understanding in writing as there will be a mutual trust binding these investors. However, managing a Company (even a Private Limited Company) with quite a few Shareholders turns to be tough task if the Shareholders / Co-investors are less known to each other. In such cases, SHA comes to rescue.
What does SHA contain?
The main purpose of SHA is to protect the Shareholders investment in the company, to establish a fair relationship among st the Shareholders and to govern how the Company is to run. Following would be the main contents in SHA:
- Rights and obligations of the Shareholders
- Regulation on how and to whom the Company’s shares are to be sold / transferred
- Method of valuing the business / shares of the Company
- Describing how the company is going to be run
- Defining the duties and responsibilities of each Shareholder
- How minority shareholders are protected
- How the Shareholders have to decide on important aspects to the Company
How will SHA help Shareholders?
Generally, shareholders are classified under two categories – Majority and Minority. Majority shareholders are those who collectively hold more than 51% of the Share Capital of the Company, whereas Minority are the ones who collectively hold less than the said ratio.
We all know that ultimately all the decision on the affairs of a business of a Company, be it operational or managerial, is decided by the Shareholders. Equity Shareholders have voting power in all the General Meeting of a Company. Suppose there is a situation where two set of shareholders are not in agreement with some decision, the decision made by the Majority Shareholders suppresses the decision of Minority Shareholder.
There might be a contrary situation where due to non-agreement by Minority Shareholders, the decision of Majority Shareholders gets invalid. Classic example of this situation is in case of a proposal for sale of the company to a third party as a going concern and the intended buyer wants the entire 100% control of the company, but the Minority Shareholders do not agree for this transaction. Here the entire transaction may not be executed at all due to Minority Shareholders disagreement.
Generally, few start-up companies have an intention to develop a product, take it to the market, once the business is gains momentum, sell the company to a bigger organization. Intention behind such a transaction may be to come out of the operational hazards which is not the promoter’s core talent or may be to make money from the asset developed by these promoters. In such a case if any of the Shareholders disagree to sell, the Majority Shareholder does not have a choice but to back off the sale offer.
If in both the above situations a SHA was in place, there would have been a better understanding among st the co-investors and a strategy might have been framed to accomplish the Company’s business objectives. In other words, having SHA will protect the interests of Minority as well as Majority Shareholders and makes the business of a company go smooth. It all depends on how well the SHA is drafted and its legal validity.
Conclusion
In a dynamic country like India, business is always complex. Be it internal management of the company or external competition in the market, it is always better to have a goal driven organization. SHA is one of the tools which helps an efficient internal management of the company.
Disclaimer:
Best efforts have gone into compiling the above information. However the author is not responsible for any consequences occurring directly / indirectly based on decisions taken from the above information published.
Special thanks to Nirush, CA Article, who has helped this piece of information get a good shape.
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What is possibilty to enforce the SHA under indian law if someone not agree as agreed by SHA