Shareholders Agreement

Every entrepreneur wants funds with the maximum freedom to run the company independently. On the other hand, an investor tries to protect his investment if the company does not perform well.

Investor wants certain rights to be protected so that money invested shall not be misused. There is no doubt about that investor by investing in the companies gets certain rights including voting rights under the companies act, 2013. The investor also wants the promoters to stay invested in the company. He does not want the promoters or founders to do other activities.

To protect all these rights of investor, it is very important to enter into some sort of agreement which balances the entrepreneur and investor's right appropriately. Shareholder agreement serves this purpose. A shareholder agreement is a very elaborative document.

Let's look at some of the important clauses of shareholder agreement:

1. Return on investment:

An investor invests in the securities of the company to earn more money in the term of profit. When investor investment in the shares of the company whether it is a private limited company or public limited company, his source of earnings are the dividends.

But in the case investor invests in the debenture of the company then he earns the interest. Debentures are considered as a safer investment because debenture holders get more security in getting a secured return as compared to the equity share holder. Even in the case of winding up of the company, debenture holders are given preference to pay back the money. Equity shares holders are the last in the queue.

2. Protecting rights:

Basically, investor force to insert the clause to take veto rights against the issue of new shares of the company to maintain his or her stake. Veto rights against the issue of new shares of the company mean that company can not issue further shares with the consent of the investor.

3. Anti-dilution rights:

First, understand what the dilution of rights in respect of shares is. When company issue new shares to the outsider then % holdings of the existing shareholders automatically reduce due to increase in number of shares.

Therefore, this is only triggered when company valuation is reduced in the subsequent round of funding.

These are some of the most important rights or clause which must be in the shareholder agreement. Since giving effect to all these conditions, a draft of agreed version of Articles of Association shall be prepared in advance.