The Meaning and Most Important Provisions of Shareholders’ Agreements
This agreement clearly defines the relationship between various shareholders and their rights and obligations in the management of the company. Therefore, this is an important document that must be regulated. When a startup seeks funding, investors want to document the agreed terms and protect their profits. Investors have legal support to protect their interests, but as startup founders, they should also be familiar with the important clauses of shareholder agreement in India.
How to protect your interests with these 6 mandatory clauses!
Participation in important decisions
Some investors come to an organization with technical expertise, while others are only interested in numbers. Such silent investors give the founders the freedom to run the business, but they participate in important business decisions. The investor’s role must be clearly defined in the contract. In principle, it is ideal to list the events and circumstances that require investor approval. Such decisions may include appointing or removing directors or CXOs, expanding the scope of business, issuing additional equity or investments, etc. The type of participation should also be clearly defined. Some investors appoint candidates to the board, while others have a written approval policy. Some decisions may be time sensitive, so mechanisms should be developed for rapid approval or consultation.
Right of Refusal and Anti-dilution Protection
Participation and ownership go hand in hand. Both founders and investors want their holdings to remain unchanged. A preemption clause obliges the company to first offer new shares to existing shareholders in proportion to their current participation. This clause will come into effect if all existing shareholders are willing to continue investing. Anti-dilution clauses play an important role when a company offers new shares to new investors. Because of the anti-dilution clause in the startup’s shareholder agreement, investors can keep their holdings unchanged without further investment. So if an investor has his 10% current interest in his 1 Cr capital, and a new investor contributes another 5%, the current investor automatically gets his 0.5% will be assigned and interest/votes will not change. As a founder, you should be careful when disclosing anti-dilution provisions. Doing so may dilute your interest in the company.
Right of First Refusal
This shareholder protection restricts the transfer of shares. As the number of shareholders/investors increases, they may lose control or influence over the company. A stock transfer is a way to increase the number of shareholders without further expenditure. This clause ensures that control of the company is not transferred to unwanted third parties. Shareholders wishing to transfer their shares must first offer their shares to other existing shareholders at the same price. Offer prices are typically derived from independent appraisers. If existing shareholders are unwilling to buy shares at a particular price, the company can find another investor. That way, shareholders can control who they do business with.
Drag-Along and Tag-Along Rights
Minority shareholders are plagued with dealings with undesirable co-owners when majority shareholders want to sell their holdings. Bring-on rights protect the interests of minorities in such events. Also known as a piggyback right, this allows minority shareholders to sell their holdings at the same price and terms if they wish. Tag-along rights empower minorities, while drug-along rights favor buyers. Drag-along-right drags out minority shareholders and forces them to sell the company for the same price and on the same terms. This allows the buyer to receive his 100% of the shares.
Opt-out or Termination Clause
This shareholder agreement stipulates what happens if a shareholder leaves the company under other circumstances. When important milestones are reached, founders tend to offer acquisitions or investors want to exit the business. Given such milestones, this clause provides an exit method for investors and founders. Shareholders often exit at a fair price or with a guaranteed premium at the time of acquisition.
Shareholders, often referred to as bad turnovers, are those who fail to meet the major commitments or major milestones originally set out in the contract. The parties may adjust this provision based on each party’s material obligations. As a general rule, the failing party must offer shares to the company or other existing shareholders at a discounted price.
Dispute Resolution
Partners usually try to resolve disputes amicably. Dispute resolution clauses are a last resort, but preferable to a suspension that can severely impact business operations. A shareholder agreement should establish a process for resolving disputes between shareholders. Or shareholders and companies. Arbitration or out-of-court settlements are the preferred ways to stay out of legal disputes. Leave it to the professionals!
Of course, drafting a shareholder agreement for a startup requires professional legal assistance. Done perfectly, it reduces uncertainty in the event of disagreement. Our team at LegalWiz.in has worked with promising and disruptive start-ups to provide all-in-one solutions for your daily legal needs. Ready for your next ride? Please enter your details. We will get back to you shortly.
