A Look at Shareholder’s Agreement – Everything Startups Know About
Shareholder’s Agreement refers to an agreement that takes place among the shareholders of the company where purpose is to regulate their relationship and certain related matters. Shareholder Agreement can provide the exact ownership stake each partner will enjoy along with incumbent obligation.
Whenever, somebody thinks of launching a business that will involve contribution of more than one individual either financially or otherwise, it is extremely important to ensure the right acknowledgement for their contribution.
Thus shareholder’s agreement plays a vital role in taking care of the security and accountability of such shareholders. Sometimes even non-company contents like management rights, licensing intellectual property etc. are commonly included in the shareholders’ agreements.
The above list includes the essentials that are a must in any shareholders’ agreement. We’ll discuss these one by one:
1. Rights related to the issuance, sale, or subsequent distribution of shares: All the rights that deal with issuance of shares, sale of shares and also their subsequent distribution would come under this category. It will also include pre-emptive rights and first refusal
Rights related to the issuance, sale, or subsequent distribution of shares
Roles and obligations of each shareholder
Restrictions on transfers of shares
Composition of the board of directors and related duties
Warranties from the management team
Special rights for certain shareholders
Exit clauses or mechanisms
2. Roles and obligations of each shareholder: This would include obligations of existing as well as those of future shareholders.
3. Restrictions on transfer of shares: They are predefined in the shareholder’s agreement. Such as in many instances investors will be very keen to ensure that the management team which they are backing, hangs on to their shares. In certain circumstances, managers will be permitted to transfer shares to family or to trusts.
4. Composition of board of directors and related duties: The agreement may allocate the rights to certain stakeholders to be a director on board as well as decide the composition of the Board.
5. Warranties from the management team: These are a series of statements about the company which the investors would expect to be true and accurate. Once the company has a track record, then the warranties can extend to general trading affairs of the company.
6. Special rights for certain shareholders: This strategy is often employed by firms to maintain the interests of its shareholders. However, any information in this regard needs to be clearly mentioned in the agreement.
7. Exit, Clauses or Mechanisms: This would involve rules, regulations and other proceedings required while a shareholder exits either voluntarily or due to any other contingency.
Major Clauses Some of the most prominent clauses relating to transfer of shares include:
I. Right of First Refusal: A First right of refusal clause makes it obligatory on a shareholders who wants to sell his shareholding, to first offer his shares to the other shareholder who is party to the Shareholders’ Agreement on the same terms and condition on which he proposes to sell it to a third party.
II. Lock-in clause: A lock in clause impose restrictions on alienation/sale of shares held in the company by either party without prior approval of other party for a certain period of time.
III. Drag Along Clause: If the Shareholders’ Agreement has a drag along clause then in the event that one shareholder wishes to sell his shares to a third party, then he can require the other shareholder who is party to the Shareholders’ Agreement to also sell his shares to the same third party on the same terms and conditions.
IV. Tag along Clause: A tag along clause gives a (minority) shareholder the right to insist that his shares can also be sold to a third party to whom the other shareholder proposes to sell his shares, on the same terms and conditions.
V. Anti dilution Rights: In case the company issues shares to any other person at a price lower than the price at which a shareholder who is party to the Shareholders’ Agreement was issued shares, then the shareholder who is party to the Shareholders’ Agreement has the right to receive such additional shares (at no cost to him) so as to reduce the price per share held by him to the same price as that at which shares were issued to the other person.
VI. Pre-emptive Rights: It obligates the Company to offer any future shares that may be issued, first to the Shareholder (on a pro rate basis) before offering it to any other party and may allow the shareholder to continue maintaining its shareholding percentage in the Company.
Reasons for having a Shareholder’s Agreement
1. Confidentiality: Any sort of details or information mentioned in the agreement is kept confidential as a shareholder’s agreement does not have to be registered on the Companies Register, unlike a company constitution which is viewable by the public. The shareholder agreement is only seen between the shareholders in the company. Thus the security and confidentiality is fully maintained.
2. Pre-Incorporation: A shareholder’s Agreement can be prepared before the actual incorporation of the company. Thus shareholders can enter it before hand. This makes them to have a clearer idea of what they are entering into and the general direction and purpose of the company. This could also include how the shares will be issued and whether initial funding will come from shareholder loans or third party loans.
3. Resolution: In case of any future dispute or deadlock, provisions can be made for its resolution. The shareholders agreement can provide options for the shareholders where a deadlock exists on a major company decision. One example is having a put/call option where one shareholder can purchase the others shares in the event of a deadlock where a deadlock cannot be resolved.
4. Flexibility: The shareholders agreement can be tailored to suit the company’s needs. The agreement is made in such a manner that it takes care of interests of all the
shareholders along with keeping the position of the company intact. The agreement can be as simple or as detailed as the shareholders want.
5. Rights Protection: The shareholder’s agreement is made to protect the rights and interests of all the parties involved. This would also include powers granted for minority shareholders by requiring unanimous approval for important company decisions
Basic functions of Shareholders agreement are:
– setting out the shareholders’ rights and obligations;
– regulating the sale of shares in the company;
– describing how the company is going to be run;
– providing an element of protection for minority shareholders and the company;
– defining how important decisions are to be made
At Starters’ CFO, we can assist you in providing all sorts of details regarding Shareholder’s Agreement along with serving as an helping aid for your organization to provide all sorts of legalities and compliances involved.