A business venture that attracts investors is sure to be exciting and rewarding. New growth and expansion opportunities will be opened up. In addition, when you sit across the table from your investors, you will need to prepare a detailed and definitive shareholders’ agreement.
A shareholders’ agreement’s importance and key clauses
In this agreement, the different shareholders are clearly defined along with their rights and responsibilities with respect to the Company’s management. So, Articles of Association should be aligned with it. Investors are interested in protecting their interests when start-ups invite funding. Aside from the support of their advocates, investors have to familiarize themselves with the most essential clauses in an Indian shareholder agreement.
Here’s how you can protect your interests with these six must-have clauses!
- Participation in Critical Decisions
Most investors are interested in the numbers, but a few will bring technical expertise to the organization. Though dormant investors give founders free rein to run their companies, they are nonetheless involved in critical decisions. An investment agreement must clearly define the investor’s role. In an ideal scenario, it should describe the situations and conditions in which in-principle investor approval will be required. Decisions would include appointing or removing directors or CXOs, expanding a business line, issuing more shares, or making capital expenditures. How the participation is done should also be clearly defined. In some cases, investors nominate their nominees to the Board, while in others written consent rules apply. Some decisions have a short timeline, so you should devise a method for approving them or consulting them quickly.
Pre-emptive Rights and Anti-dilution
Equity stakes and ownership are closely related. Venture capitalists and founders both want to maintain the same holding. The pre-emptive rights clause requires that the Company first offers the new shares in proportion to the current shareholdings to the existing shareholders. The clause is valid whenever all of the existing shareholders are willing to continue investing. A company’s anti-dilution clause is crucial when it offers new shares to new investors. Your startup’s shareholders’ agreement should include an anti-dilution clause to allow investors to maintain their holding without further investing. Thus, if an investor is holding 10% and another investor is bringing in 5%, the existing investor will be auto-allocated 0.5% to maintain their ownership/voting. Giving away anti-dilution clauses should be carefully handled by founders because it may dilute your stake in the company.
Right of First Refusal
Shareholder protection clauses restrict the transfer of shares. With increased shareholder/investor numbers, you may lose influence and control over the organization. An attempt to increase shareholder numbers without further issue can be accomplished through the transfer of shares. Clauses such as this prevent undesirable parties from gaining control of the business. Before transferring their shares, an existing shareholder must first offer them to other existing shareholders at the same price. Independent valuers typically establish the offer prices. It is possible for the Company to find another investor if the existing shareholder is not willing to purchase the shares at the given price. Thus, the shareholders will be in control of how they do business.
- Drag-Along and Tag-Along Rights
By being in business with unwanted co-owners when the majority wishes to sell, the minority group suffers. Tag-along rights protect minorities’ interests at such events. Minority shareholders can get the same price and terms for the sale of their holdings if they elect to do so, which is also known as piggyback rights. Drag-along rights favor buyers while tag-along rights give power to minorities. In drag-along rights, minority shareholders are forced to agree to the terms and price of the sale of the company. If the buyer is granted 100% ownership, the minority shareholders are forced to concede their rights.
Exit or Termination Clause
According to this shareholders’ agreement clause, shareholders who leave the company under different circumstances are responsible for certain obligations. Upon reaching significant milestones, founders frequently offer buyouts, and investors want out. It may also define the manner in which investors or even the founders may exit if such milestones are predefined. The shareholders often take a guaranteed premium on acquisitions or take exits at fair value.
Shareholders who leave a business without fulfilling their obligations, or fail to meet important milestones, are known as bad leavers. A clause like this may be tailored to each party’s material obligations. Generally, the defaulting party must offer discounted shares to the existing shareholders or company.
Resolution of Disputes
A dispute between shareholders has usually settled amicably. Even though it is the last resort, a dispute resolution clause is preferable to a deadlock that may adversely affect the business. Ideally, your shareholders’ agreement should specify a process for resolving shareholder disputes, or shareholder disputes with the corporation. The best way to avoid becoming enmeshed in litigation is to mediate or reach an out-of-court settlement.