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How to make Shareholder Agreement

Introduction

Shareholder agreement is a well drafted written agreement between company’s shareholders specifying the framework of the company in the sense that how it is to be operated and organized, what are the rights and liability, how the shares of stock would be issued along with restriction upon transfer of shares, management of corporation and privileges and protection of and rules regarding appointment of board of directors and other officials. It aims for systematic procedural for fair treatment of shareholders and their rights are protected and also allow shareholder to legislate on outsider parties to become future shareholder and provide them safeguards for proper functionaries of the company.

Key Elements

• The share capital of the company are evaluated to represent the ownership of shareholders wherein it provides the details of subscription of shares, capital structure, timeline of payment and thereby showing the relationship between shareholder and company.

• The transfer of shares is absolute in case of family or trust but there are some restrictions on selling of shares to third parties and for that matter, it requires a written consent from existing shareholders. There are clauses of forced transfer like drag alone rights, buy back rights, tag alone rights etc. For instance, at one hand, in drag alone rights provide a way to majority number of shareholder who wanted to sell their shares to third party then minority shareholders could be forced to sell their shares and on other hand, tag alone right in which if majority of shareholder want to sell shares to third party then minority shareholders has the right to include their shares in the sale.

• The restricted activities clause in the agreement ensures that both majority shareholder who owns more than 50% of company shares and minority shareholder have a say in important decision of the company like appointment or removal of director, dividend sharing ratio, issuance of shares, entering into major deals, etc.

• The agreement among all shareholders agreed upon the confidentiality of the information of commercial value and any disclosure of fact could be amount to material breach and might lead to termination of the shareholder.

• There is a collateral or penalty interest on all shareholders because of the fact that every shareholder is acting under representation and warranties of other shareholder in formulated any decisions and in the event of material breach or misrepresentation of shareholder then it would indemnify other shareholder for such loss incurred to them.

• The clause specify the vesting period of shareholders i.e. the period of investment by shareholders for a specific period before they get the benefit of shares. For example, after vesting period is achieved like revenue target then agreed percentage of revenue will be provided to the shareholders.

• In case of dispute, it is open to include the clause of dispute resolution mechanism in case of deadlock among shareholders regarding any matter whatsoever during course of working in the company.

STEPS TO DRAFT SHAREHOLDER AGREEMENT

1. PARTIES TO THE AGREEMENT

The agreement requires that all shareholders becomes the party to the agreement and must be legally approved by all through signing the agreement after reading all terms and condition applied to the agreement. It must also specify the agreed definition of the relevant meaning to the main words like buyer, seller, shares, board of directors etc. The structure of the company should laid down the role and functions of each members such as whether vote for board member need to be majority vote or some required percentage, how often board must meet to discuss the problem or issues and minimum no of shareholder to conduct the meeting, who to authorize for salary or commission and dividend sharing or undertake a loan in the name of company.

2. RIGHTS AND OBLIGATION

The agreement must include following rights and obligation of shareholders:

• Provision for death or incapacity of the shareholder
• Veto power against over board’s decision
• What types of information does the shareholder has the right to access like financial statement, board report and management record of shares
• The right of first refusal should be granted to shareholders in which before selling of shares to public at large, option must be provided to existing shareholders to buy the shares.
• Establishment of observer rights to the investor wherein they can attend board meeting and receive the information of board member but cannot veto in the major decision. It also provides the investor to invest the amount of capital and how he can be removal from observer status.
• The obligation of the company must be agreed upon and sign by representative of the company at the time of making of the agreement and may include: preparation and delivery of report to shareholders, annual financial statement, maintenance of director and official liability insurance.

3. RESTRICTION ON SHARES OF THE COMPANY

The agreement can restrict the transfer and selling of the shares with respect to shareholders by providing following measures:

• In case of investment funds, it may allow the transfer of shares to another investment fund under the control of shareholders.
• In case of individual shares, it could be transfer or sold to corporation owned by his/her family.
• For free consent of the transferee, it may include permitted transfer provision which will state the real intention of transferee to transfer shares without coercion.
• The agreement can include that if a shareholder dies, become insolvent then company has the right to repurchase the shares of the shareholder and can offer for resale to other shareholders or public at large.

Conclusion

The shareholder agreement proves to be unambiguous written document which assist the court of law to question the legally binding clause for the purpose of settling the dispute and also clarification of how are the parties who originally intended. It is also beneficial to the company which has more number of active shareholders who are keen in investing the amount of capital to the company and in return secures its shareholders by providing insurance coverage and protects against any loss incurred by executing indemnity policy to all its members.

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