What is Shareholder Agreement & Its Important Clauses

  • July 29, 2016
  • Update date: December 04, 2024
  • Dushyant Sharma

Post updated on: 06-11-2024

In this blog post, we will learn about what is shareholders agreement, its benefits and its clauses.

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.

Investors want certain rights to be protected so that money invested shall not be misused. There is no doubt that investors by investing in the companies get 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 shareholder, it is very important to enter into some sort of agreement which balances the entrepreneur and investor's rights appropriately. To serve this purpose, a shareholder agreement is put into place. It is an elaborative document with various clauses. 

What is a Shareholders Agreement?

A shareholders’ agreement is a legal contract between shareholders of a company. It outlines the rights and responsibilities of all the shareholders in the company, as well as the company’s management and corporate governance structure.

The goal of agreement of shareholders is to safeguard shareholders' interests, particularly those of minority shareholders who control less than 50% of the company's shares.

A shareholders' agreement is particularly crucial for businesses with numerous shareholders, even though it is not required by the Companies Act 2013. It can help in guaranteeing that shareholders receive the benefits they agreed upon when they invested in the business and that they are treated fairly.  

Benefits of Shareholders Agreement

Although having a shareholders agreement is not a legal obligation, its value should never be underestimated by shareholders of a company. This agreement offers the following advantages:

  • It controls the relationship between shareholders and governs the company’s management.

  • It provides protection for each shareholder by outlining their rights and responsibilities in the business.

  • It can assist in settling future conflicts. This is due to the fact that this agreement usually describes how to handle common problems that occur inside a private limited company. 

Important Clauses of Shareholders Agreement

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

1. Return on investment clause

An investor invests in the securities of the company to earn more money in the term of profit. When an investor invests 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 an 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 shareholders are the last in the queue. All this must be mentioned in the clause.

2. Protecting Rights Clause

Basically, investors 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 the company can not issue further shares with the consent of the investor.

3. Anti-Dilution Rights Clause

First, we shall understand what the dilution of rights in respect of shares is. When a company issues 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.

4. Disputes Resolution Clause

Dispute resolution clause in a shareholders agreement is designed to offer a roadmap for conflict resolution in an efficient way and helps to reduce harm to the business operation. The clause must be in accordance with the Indian Arbitration and Conciliation Act, 1996. The Act provides a framework for arbitration - a method for resolving disputes outside the court.

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

Conclusion

A shareholder agreement is a crucial document for private and public limited companies in India. Although it is not mandatory for companies, having this document in place helps to define rights, obligations and responsibilities of shareholders. Further, it can help to resolve disputes between shareholders. 

If you liked this post, do check out the rest of Registrationwala’s blog posts in the Knowledge Base section.

Frequently Asked Questions (FAQs)

Q1. What happens if a shareholders agreement conflicts with the provisions of the Companies Act, 2013?

A. In the event that a shareholders agreement and the Companies Act 2013 clash, the Companies Act's provisions will be applied.

Q2. Can shareholders agreement be amended?

A. Yes, a shareholders agreement can be amended in India as long as the consent of all parties involved is obtained.

Q3. Is shareholders agreement mandatory in India?

A. No, a shareholders agreement is not mandatory under any Indian laws.

Q4. What does a shareholder form consist of?

A. It typically includes the following sections: parties, board of directors, shareholder information and meetings, competition restrictions, share capital and share transfers, amendment and termination, mechanisms for resolving disputes, etc.

 


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Dushyant Sharma
Author: Dushyant Sharma

Hey there, I'm Dushyant Sharma. With the extensive knowledge I've gained in past 8 years, I have been creating content on various subjects such as banking, insurance, telecom, and all the important registration and licensing processes for various companies. I'm here to help everyone with my expertise in these areas through my articles.

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