VITAL CLAUSES OF SHAREHOLDERS’ AGREEMENT

Introduction

When thinking of major companies in India, names like Reliance Industries Limited, Adani Power Limited, and Hindustan Unilever Limited often come to mind. However, small and medium business owners also prefer the business structure of a Company over partnerships or sole proprietorships due to its numerous benefits. According to the Companies Act, 2013, there are several types of companies:

• Public Company
• Private Company
• Company Limited By Guarantee
• Company Limited By Shares

Every company limited by shares must have share capital, divided into smaller units known as “shares”. A “share” represents a unit of share capital. The share capital of a company can be altered or increased under certain conditions.

A Shareholders’ Agreement outlines and regulates the relationship between a company and its shareholders. While not mandatory, it is crucial due to the significant benefits it offers.

Benefits of a Shareholders' Agreement

• Defines the Entire Arrangement: It sets out the arrangement between the company and its shareholders, ensuring clarity and stability.
• Confidentiality: Unlike public documents (e.g., Memorandum of Association and Articles of Association), a Shareholders’ Agreement is a private document offering confidentiality.
• Protection from Hostile Takeovers: It provides greater protection to shareholders from hostile takeovers.

Important Clauses of a Shareholders’ Agreement

1. Pre-Emptive Right/Anti-Dilution Protection: This clause protects shareholders from having their shareholding diluted in future funding rounds. Shareholders have the right, but not the obligation, to participate in new issues to maintain their percentage shareholding.
2. Right of First Refusal: This clause protects the company from hostile takeovers by allowing it the first right to purchase shares before they are sold or transferred.
3. Drag Along and Tag Along Rights:
   • Drag Along: Allows majority shareholders to force minority shareholders to sell their shares if a third party wants to purchase the entire company.
   • Tag Along: Allows minority shareholders to participate in a sale by the majority shareholders on the same terms and conditions.
4. Liquidation Preference: Determines the payout order in the event of the company's liquidation, giving preference shareholders priority over other equity holders in receiving payments.
5. Dispute Resolution: Specifies how disputes between shareholders and the company will be resolved, often through alternative dispute resolution methods like arbitration or mediation. It provides flexibility and avoids home court advantages.

Conclusion

A Shareholders’ Agreement is crucial for safeguarding investor capital and interests in any venture. It defines shareholder rights, protects against hostile takeovers, and standardizes dispute resolution mechanisms, making it essential for both companies and investors.