A shareholders agreement is an agreement between shareholders which outlines how a company should work and conduct itself. Referred to as a stockholder agreement, it covers crucial aspects such as company management, shareholder privileges and protection. In essence, it safeguards both the company itself and the investments made by the shareholders.
A shareholders’ agreement significantly influences the functioning of a company, as it establishes a binding connection between the shareholders and the company. Several reasons justify the necessity of a shareholders’ agreement and highlight its pivotal role.
Benefits of Shareholders Agreement
There are various advantages of drafting a shareholders agreement, which may include:
More control in the hands of the shareholders:
One notable benefit is that it grants greater control to the shareholders. Although the board of directors typically manages the company’s day-to-day operations, a shareholders’ agreement introduces specific reserved matters outlined in the contract. Consequently, these matters necessitate shareholder approval before implementation, as opposed to being solely determined by the board of directors’ discretion.
Avoiding shareholder disputes:
By including provisions for dispute resolution in the shareholders’ agreement, many potential conflicts that commonly arise among shareholders can be resolved or even prevented altogether. This outlines the framework and procedure for addressing disputes, offering a clear path to finding resolutions.
Stability of business:
Ensuring business stability is a crucial aspect that can be accomplished through a shareholders’ agreement. This stability holds significant value for creditors, banks and prospective investors who may be considering investing in the company. Moreover, it serves as tangible evidence of a harmonious relationship among shareholders, establishing a positive image for the company.
Restrictions when exiting the company:
When a shareholder exits the company, the company’s legitimate business interests are protected through the operation of restrictive covenants, which would not exist if a shareholders’ agreement did not exist.
Protection for the majority and minority shareholders:
Protection for the majority and minority shareholders is facilitated through the inclusion of ‘drag along’ rights in the shareholders’ agreement. These rights empower the majority shareholders to overcome any potential hurdles posed by minority shareholders who may not consent to sell their shares to a buyer seeking to acquire the company. Conversely, the minority shareholders are afforded participation in a sale initiated by the majority shareholders, thanks to the ‘tag along’ provision within the shareholders’ agreement.
Control over share transfers:
The shareholders’ agreement addresses share transfer provisions, such as transfer restrictions and pre-emption rights. These provisions serve as practical measures to ascertain the individuals entitled to acquire and possess shares in the company.
Contents of a Shareholders Agreement
There are some essential aspects that a shareholders agreement usually covers, which are:
Parties Involved In The Agreement:
In the shareholders’ agreement, the company is acknowledged and identified as a separate party from the shareholders, who are considered as another party.
Board Of Directors and Board Meetings:
One of the elements stated in the agreement would be the role of the board of directors and how the majority should approve the decisions of the board. It also includes specific details regarding the frequency with which such meetings should be held and also the process for selecting and replacing directors.
Rights of a Shareholder:
A shareholder is entitled to certain rights concerning the company. Hence, the shareholders’ agreement outlines these rights. Some of the rights that shareholders may have are as follows:
– The right to request a General Meeting
– The right to vote
– The right to appoint directors and take legal action against them
– The right to appoint the company’s auditor
– The right to access and review the company’s registers and books
– The right to request copies of the company’s financial statements
– The right to be informed about the company’s winding up process
Liabilities of a Shareholder:
Shareholders are not responsible for the actions of the company, as it is commonly understood. However, they may bear liability limited to the unpaid portion of the share capital attributable to their held shares. In cases where the company is limited by guarantee, shareholders may be liable up to the extent of the amount they have guaranteed. The principle of limited liability is rooted in the concept that the company is an independent legal entity separate from the shareholders, thus resembling a distinct party. Consequently, it becomes crucial for a shareholders’ agreement to specify the liabilities of the shareholders.
Reserved Matters:
A comprehensive shareholders’ agreement should delineate matters that necessitate the unanimous consent of all signatories, typically involving majority support. By formulating a list of reserved matters, all shareholders are provided with an opportunity to evaluate specific transactions to determine their potential impact on their investments. These reserved matters commonly include information pertaining to the acquisition or disposal of certain assets, dividend payments, alterations to the Articles of Association and Memorandum of Association, modifications to the share capital structure and the assumption of new debt, among others.
Shareholders’ information and meetings:
Receiving information and regular updates about the company and its performance is another requirement of this agreement. These updates come in the form of quarterly and annual reports. The agreement should specify the particular period during which these reports will be dispatched to the shareholders. Additionally, the shareholders’ agreement must outline the details regarding the scheduling of shareholder meetings, including the dates, times and venues.
Share capital and share transfers:
Moving on to share capital and share transfers, it is crucial for a shareholders’ agreement to document the company’s share capital at the time of signing. Since altering the share capital falls under reserved matters, the directors are prohibited from issuing new shares or converting existing shares into a different share class without obtaining approval from the signatories. Moreover, the shareholders’ agreement should encompass provisions pertaining to share transfers. These provisions aim to prevent share transfers to undesirable parties, facilitate transfers to new parties, establish consequences in the event of a director’s or shareholder’s death and incorporate “drag along” and “tag along” provisions.
Amendment and Termination:
The agreement should have clear provisions if there’s a need for amending and/or terminating a shareholders’ agreement. Another option is to reach a written agreement among the shareholders. Additionally, termination can occur after a specific period has passed since the agreement’s date.
Procuring Finances for the Company:
Shareholders are vital in monitoring the company’s progress and financial requirements. By receiving copies of the financial statements, shareholders can stay informed about the company’s needs. If shareholders determine that the company requires additional funds for growth, they can identify suitable funding sources. It is important to outline the procedure for obtaining such finances within the Shareholders’ Agreement.
Protection Of Minority Shareholders:
Since minority shareholders own less than fifty per cent of the company’s shares, they enjoy limited influence compared to the other major shareholders. Due to this reason, the agreement must include provisions for the protection of minority shareholders. The Companies Act of 2013 delineates the rights of minority shareholders, which include:
- The requirement to appoint a Small Shareholder Director
- The right to approach the Board in cases of oppression or mismanagement
- The right to participate when the majority shareholders sell their shares, known as Piggy Backing.
- The right to initiate a class action lawsuit against the company and its auditors.
Risks in Shareholders Agreement
In certain conditions, shareholders’ agreements carry certain risks, although primarily intended for protection. These risks include:
- The rights, responsibilities and obligations of each shareholder may become ambiguous without a well-drafted shareholder agreement, potentially resulting in disputes and conflicts.
- Minority shareholders could be exposed to unfair treatment or oppression by majority shareholders in the absence of a shareholders agreement, as there are no specific provisions to protect their interests.
- The transfer of shares may lack restrictions or guidelines without a shareholders agreement, leading to undesirable outcomes such as shares being sold to unsuitable or unwanted parties.
- Disagreements among shareholders can cause decision-making deadlock and hinder the company’s ability to make crucial decisions when clear mechanisms for decision-making and dispute resolution are absent.
- Shareholders may encounter challenges when attempting to sell their shares or exit the company without provisions addressing exit strategies, such as buy-sell provisions or rights of first refusal, potentially resulting in disputes and difficulties in valuing shares.
- There may be a lack of clarity and protection regarding intellectual property rights without a shareholder agreement, which could impact ownership, usage and licensing.
- In the absence of non-compete clauses, shareholders might have the freedom to compete directly with the company, posing risks to its market position, customer base and trade secrets.
- Ambiguity may arise regarding the distribution of profits and dividends among shareholders without clear guidelines in a shareholder agreement, potentially leading to disagreements and disputes.
Final Thoughts
The main intention behind a it is that the company goes through a smooth functioning which the agreement ensures by giving a sense of clarity and structure to the relationship between the organisation and the shareholders.
By including provisions and terms, a shareholders’ agreement contributes to the efficient and timely resolution of disputes. Consequently, this fosters a positive perception among potential investors, banks and creditors towards the company, highlighting the healthy relationship among the shareholders.
For more details, connect with our experts at StartupFino.
