‘A contract defining shareholders’ rights and obligations’
When an individual is planning to establish a company with family members or friends it is easy to presume that nothing can go wrong in the coming years. You might conclude that as you trust each other and you are not in need of something called as shareholders’ agreement, rather it would sound that you are not trusting them if you put forth an idea of shareholders’ agreement.
Probably nothing will go wrong in the future. But even the family members and best friends fall out and you could then end up with literally nothing. Or you might have to face the breakdown of a friendship accompanied by a costly legal dispute related to the business.
A shareholders’ agreement is usually a consensus between the shareholders or investors of a company. It can be between all or only between some of the shareholders. Its motive is to secure the shareholders’ investment in the company as well as to maintain a just relationship between the shareholders and to administer the functioning of the company. The main purposes of the agreement are:
- To set out the shareholders’ rights and duties
- To manage the sale of shares in the company
- To describe the functioning process of the company
- To provide protection for minority shareholders and safeguarding their interests
- To define the process of making important decisions
The shareholders’ agreement will consist of particular, significant and practical rules relating to the company and the relationship between the shareholders.
Some Salient Features of a Good Shareholder’s Agreement are:
- Nomination of Directors
- Roles and rights of each shareholder.
- Financing and quorum demands as well as veto rights.
- Representation & guaranties from the Company.
- Restraints on transfer of shares
- Forced transfer of shares and cutting down further issue of shares.
- Determining Shareholding Threshold i.e. must have a minimum shareholding given to a party for the party to enjoy the rights according to the Shareholding Agreement.
- Establishing and assigning special rights to specific shareholders
- Issuing and transferring shares
- Providing some protection to the minority shareholders (having less than 50% of shares in the company)
- Functioning of the company that includes appointing, removing and paying directors, determining the company’s business, making capital outlays, providing managerial information to the shareholders, providing banking arrangements and financing the company.
- Paying the dividends.
- Competition limits.
- Procedures for resolution of disputes
Shareholders’ agreement for a minority shareholder:
Lack of shareholders’ agreement will lead to the minority shareholders having little control in the functioning of the company. The control will mostly rest with one or two shareholders. Companies are normally run by decisions made by the majority and though the articles of association include provisions that safeguard the minority shareholders, these can be amended.
Being a minority shareholder, it is very crucial to have a shareholders’ agreement that includes the compulsion for all shareholders to approve certain decisions makes sure that you have a say in the key decisions that influence the company. This could be the decision on the matter of new shares, selection or removal of directors, taking new loans or changing the main trade business etc.
Shareholders’ agreement for a majority shareholder:
If an individual is a majority shareholder and he wants to sell his shares but a minority shareholder is relentless to agree then it becomes very important to include a provision forcing that shareholder to sell his shares. This is generally known as a “drag along” provision. This will allow you to realise your investment at a time and at a price that you feel is good. Although the price and other payments for the sale need to be fair and just for all the shareholders, whether minority or majority.
Also if a majority shareholder wants to prevent minority shareholders to pass on confidential information of the company to competitors or establishing rival businesses, these terms can be included as a provision within a shareholders’ agreement.
Another issue is when one of the fellow shareholders transfers his shares to anyone. This could be problematic if the sale is made to a competitor or someone else whom other shareholders do not want to get involved with the company. To sort these issues, shareholders’ agreements will usually include rules about share sales and transfer i.e. who shares can be transferred to, on what terms and conditions and at what price.