A Shareholders’ Agreement (SHA) is essentially a contract between the shareholders and the company, that lays down the rights and obligations of the shareholders with respect to the company.
When a person holds the share of a company, they also hold responsibility and accountability towards the company.
The Shareholders’ agreement makes sure all the owners of the organization equally contribute to its wellbeing and operations take place in a fair manner.
That means, everything that a shareholder is expected and obliged to do is mentioned in the agreement.
So, how does it differ from the Article of Association prepared at the commencement of the company?
Firstly, the AoA is legally mandatory to prepare while a Shareholders’ agreement is not.
Although it is not required by law, almost all companies running a business with more than one person in the company prepare this legal document.
Secondly, the shareholder agreement focuses entirely on the rights, duties, and protection of the shareholders. Whereas the Article of Association covers more topics and subtopics regarding the formation of a company.
Some terms may be similar in the two documents, but a shareholders’ agreement details all parts where owners of the company are involved.
But is it necessary to create a shareholders’ agreement? Isn’t an AoA enough?
Read on as we explore the various advantages of having a shareholders’
Advantages of a Shareholders’ Agreement
There are various advantages of having a separate shareholders’ agreement, the most important ones are listed below.
1. Protection of Minority Shareholders
Shareholders in any company can be divided into 2 broad groups – majority and minority.
Simply put, the people sitting on the chairs and running the company are the majority shareholders. They have 51% ownership in the company and take all major decisions.
The public, on the other hand, who buy some shares of the company through a stock exchange are an example of minority shareholders. They don’t have a say in the decisions of the company.
Due to this authority gap, minority shareholders can easily be exploited by the people in power.
A shareholders’ agreement ensures and grants protection, particularly to these minority shareholders, by clearly defining their rights and obligations towards the company.
This agreement makes sure that no such decision is taken by the board that harms or prejudices against the minority shareholders.
2. Provides a Clear Set of Guidelines
Imagine how a country would work without a constitution! Sounds chaotic, right?
It is the same way with a shareholders’ agreement in a company. It lays down a set of rules and regulations to be followed by each shareholder for the business to run peacefully.
Without these rules, everyone would follow individual goals instead of organizational goals. That is never good for a company!
A shareholders’ agreement sets certain policies and procedures in place with respect to how the company will be run.
It ensures a consistent and uninterrupted workflow of the organization.
3. Resolution of Disputes
What happens in the case of a shareholder fallout? Or if he/she commits fraud?
There are numerous situations that may take place in the functioning of a company. The shareholders’ agreement is referred to solve every conflict.
It minimizes the potential for future conflict by laying down every situation in advance and explaining the action to be taken for it.
For instance, if there is a conflict of interest between two of the board members, the shareholders’ agreement will dictate how to resolve the matter.
4. Gives Some Authority to Shareholders
A shareholder, by definition, is called a part-owner of the company.
Even if a person owns one stock of your company, they are some percentage owner in the company and thus deserve to have some level of authority.
Generally, the day-to-day matters of a company are looked after by the directors of a company.
By having a shareholders agreement in place, some of these decisions can be put to the vote of shareholders, requiring their approval and giving them more authority in the company.
This makes the shareholders feel acknowledged and valued. It is a great practice for the long-term well-being of your company.
Now that you understand the importance of creating a shareholders’ agreement, let’s look into the process.
Things You Must Include in your Shareholders’ Agreement
The Shareholders’ Agreement is certainly an important document of immense value.
However, it is fairly easy to draft. After all, it is your company and you can include any terms you think would be beneficial in the future.
It is a blank slate that you can customize keeping in mind the wellbeing of the company.
To get started, here are a few things you can include in a shareholders’ agreement.
1. Definitions and Interpretations
This section will lay down the definitions of certain terms which are going to be used in the rest of the document.
It provides clarity to both parties, the company, and shareholders while reading the document.
Some words or abbreviations might be brand-specific that needs to be enlisted in this section to avoid any confusion.
2. Capital Structure
This section defines the capital structure of the company in terms of the authorized share capital.
Share capital is the amount of money that the company has received from shareholders in exchange for equity. It is essential to lay down the capital structure so that the breakdown expressed in percentages is clear to everyone involved.
This section also specifies how future funding will be carried out.
Thus, if the company is in financial need, the procedure for issuing more shares is laid down in this portion of the agreement.
3. Restrictions on the Sale and Transfer of Shares
This is an important section from the point of view of shareholders.
It lays down rules and procedures agreed upon by both parties to ensure that if a sale or transfer of shares takes place, it is not against the will of shareholders, especially minority shareholders.
4. Management of the Company
A company usually has thousands of shareholders, owning small portions of the total shares.
Thus, it is not possible to consider everyone’s opinion on the decisions of the company.
In this section, you will specify the management, including the Board of Directors of the company.
This section should also include the composition of the Board, qualifications, process of voting, mode of conduct for meetings of the Board, and process of their resignation and removal.
It is important to note that the existence of a Board does not undermine the importance of shareholders in the decision-making process.
Thus, this section should also include the quorum, i.e. the number of people necessary for a meeting to be considered valid.
5. Rights and Obligations of the Shareholders
This is arguably the most important part of the agreement.
It lays down the quorum for shareholders’ meetings, the process of voting, shareholders’ rights, and their obligations towards the company.
Some rights that a shareholder can exercise in a company are- the right to vote, the right to call for a general meeting, the right to appoint the directors, the right to inspect the books of the company, tag-along rights, drag-along rights, right of first refusal, etc.
They are all mentioned in this section.
It also specifies certain special rights of the minority shareholders for their protection.
6. Representation and Warranties
As we mentioned above, the shareholders’ agreement is your blank slate that can be filled with rules and regulations that you want your company to adhere to.
However, it should be aligned with the legal system of the country and no section of the agreement should contradict or disobey any laws formulated by the government.
This section of the shareholders’ agreement ensures exactly this.
It specifies that no part of the agreement is against the applicable law, no parties involved in the agreement have any legal suit on them, and that the agreement is being formed with the consent of all the board members.
It is like a disclaimer for your shareholders’ agreement!
Any other thing left out can be mentioned in the miscellaneous section.
For instance, the procedure of termination of the agreement, arbitration in case disputes arise, applicable law that highlights which court’s jurisdiction will be followed in what case, and any other company-specific detail.
All these sections are concluded by undertakings and signatures of all the parties involved in the process.
Creating a shareholder’s agreement involves a lot of brainstorming and teamwork as you’re preparing a document for the future.
You have to lay down all the possible scenarios that may arise in the overall working span of a company.
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A shareholders’ agreement is an important tool for the effective management of a business.
Thus it must be created in a manner that sufficiently meets the needs of the company and the shareholders alike.