18 Sep 2015 20:38 IST

The importance of a shareholders’ agreement

Such a document will help specify shareholders’ obligations, restrictions on transfers and other issues

In business, it’s best that nothing goes undocumented. When you and your partners contribute money or effort in return for equity, this, too, needs to be documented. It is usually done in a shareholder’s agreement, which will declare the exact ownership stake of each partner, in addition to their obligations.

It will also ensure that directors need to follow a process while transferring shares, may give special rights to some shareholders, require that the board have a certain composition and place financing requirements on members.

While there are no set requirements of a shareholders’ agreement, the courts often frown upon clauses that are not consistent with the Companies Act, 2013 and the Articles of Association framed by the company, particularly those that curtail the rights of shareholders. If you do consider drawing up a shareholders’ agreement, you must ensure that your lawyer has a good handle on both. Let’s examine what needs to be included in a Shareholders’ Agreement:

Necessary Clauses

Obligations of Shareholders: All those party to the agreement will have their roles and obligations well-defined. The composition of the board may also be stated here. The relationship between minority and majority shareholders as well as the board and other shareholders must also be monitored.

Restriction on Transfer: Through this agreement, some restrictions may be set on the transfer of shares. Right of first refusal and right of first offer are two common clauses. There may also be some clauses forcing transfer through tag- and drag-along rights. Buy-back rights may also be defined here.

Special Rights: If you’re desperate for money from a VC, surely expect to see him place himself on a higher plane. This may be through additional seats on the board, preferential rights and much else.

Warranties: Investors will want to know that all the assets and liabilities of the company have been disclosed to them. On account of this, the directors will usually grant investors warranties up to a specified amount.

Vesting Periods: The agreement will state what happens to the shares if a director needs to leave, the vesting period for each shareholder and when they are deemed to have been offered for sale to the company and other shareholders.

Difficult Questions: You may never expect it to, but all sorts of terrible things can happen to a company. Some shareholders may want to leave, a bank may pull funding and some documents may be found not in order. The consequences of each of these can be discussed in this agreement.

vakilsearch.com specalises in legal documentation, such as shareholders' agreements.