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What Is Shareholders Agreement? How To Draft A Simple Shareholders Agreement?

what is shareholders agreement

When an entity owns and controls a stake or a share in the company, then that entity is known as a shareholder or a stakeholder.

It can be as little as one share, or as large as 90% of the shares of the company. The size doesn’t matter when it comes to defining the shareholder.

Shares mean a portion of the company, a part of the organization. By becoming a shareholder, or a co-owner in a company, the entity directly attached themselves with the results of the company. In case there are profits, then the shareholder also gets profit, and if there are losses, then it also impacts the shareholder.

As per the law, an entity is not a stakeholder or a stakeholder until and unless their name and addresses and other details are included in the organization’s register of shareholders’.

Generally speaking, the shareholders are a legally separate entity from an organization, and the debts and liabilities of a company cannot be imposed on the shareholders, and vice versa.

The rights, privileges and the financial gain of shareholders are directly related to the co-ownership conditions, the number of shares or equity that stakeholder has, at any given point of time.

And this brings us to the focus of this article, which will inform you what is shareholders agreement, and how to draft a simple shareholders agreement.

We will also suggest you ways for drafting startup shareholder agreement and small business shareholder agreement.

And lastly, we will describe the types of shareholders agreements which exist in India.

What Is Shareholders Agreement?

For anyone who holds and owns any number of equities and shares in a company, it is essential to know what is shareholders agreement.

An agreement which governs the relationship between an organization and its shareholders/stakeholders is known as a shareholders agreement.

In some jurisdictions and nations, shareholders agreement is also known as a partnership agreement, which is true to some extent: A stakeholder is also a partner in a company, and the performance of the company directly impacts their fortune and income

What Is The Need For Shareholders Agreement?

A shareholders agreement is drafted to

  • Protect the interests of the shareholders.
  • Define the roles and responsibilities of the management and the shareholders.
  • Define how the company’s important decisions will be made.
  • Create a protocol for implementing significant change in the company policies.
  • Formulate rules on the appointment of Directors, Chairman, Board members, etc.
  • Release of dividends, bonuses, and incentives.
  • Create rules for share transfer policy and more.

Say, a company promises a dividend of 10% to all shareholders on fulfilment of a condition but refuses to oblige. The shareholders, in this case, can pursue a legal course, based on the shareholder’s agreement.

Types Of Shareholders Agreement

There are basically two types of shareholders agreements:

Unanimous Shareholders Agreement and Simple Shareholders Agreement.

In the 1st type, that is Unanimous Shareholders’ Agreement, all shareholders must sign the agreement, and the power of taking decisions shift from chairman and directors to the shareholders.

Hence, in such type of shareholder agreement, the legal responsibility lies with the shareholders, and not the Chairman/Directors.

In the 2nd type, that is Simple shareholders agreement, the onus and legal responsibility of decisions lie with the promoters and management of the company, which includes directors and chairman.

Hence, the management responsibilities don’t shift to the shareholders and is considered as the most common type of shareholders agreement.

How To Draft A Simple Shareholders Agreement

Be it a startup shareholder agreement or small business shareholder agreement; there are some basic guidelines and clauses which should be present.

There are six main elements in any shareholders agreement, which should be present and explained. Using these essential elements, you can draft a simple shareholders agreement:

  • Commercial Intent: What is the commercial intent of the investor or shareholder, and how it differs from the intent of the management? This demarcation of intent should be explicitly mentioned in the shareholder’s agreement
  • Terms Of Deal: Which type of investment instrument is being provided by the management for the shareholders? For example preference share, equity share, debenture, hybrid securities etc. 
  • Protection Of Investment: How will the interests of the shareholders, especially minority shareholders, will be protected? Example being a member representing investors in the Board, voting rights of the shareholders, etc.
  • Exit Rights: In case any shareholder breaches the code of conduct and their roles, then how and how soon can another shareholder acquire the rights of those shares? How can an investor exit the investment?
  • Representations, Warranties, and Indemnity: The promoters, investees, and the management of the company should provide warranties and representations for the investment made by the shareholders. In case there is a mismatch of information or hiding any facts, then the shareholders should be able to claim indemnity.
  • Dispute Resolution: In case of any dispute, how can it be resolved, which jurisdiction will be valid, and more.

Here is an example of a Shareholders Agreement.

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