HOW SHAREHOLDERS AGREEMENT SAFEGUARDS COMPANY AND SHAREHOLDERS

A well-structured SHA goes beyond the standard Companies Act provisions and for the same key clauses should be included in the agreement.

1. Board and governance
   • This clause defines the board of directors. This includes the structure and number of board members. The clause should layout who has the right to appoint directors along with the procedure for board meetings. Appointment of independent director and observer should be addressed. Founders may reserve some rights over the decisions of the board.

2.Reserved matters

• • You may decide that some of the major decisions of the company may require a specific or majority or unanimous approval of shareholders before the same take effect. These decisions may include 

1. 1. 1. Issuing new shares or ESOP and declaring dividends.
      2. Approving budget or taking on debt.
      3. Changing the business activity of the company or amending key documents of the company like AOA.
      4. Entering into contracts with third parties beyond a certain monetary value.
      5. Appointing, removing or changing compensation of key personnel like CEO, CFO etc.
      6. Commence merger, acquisition, winding-up etc.

3. Share Capital, Vesting and Lock-in
   • This clause specifies authorised and paid-up share capital of the company. It also defines different classes of shares (equity, preference) with their privileges.
   • Vesting clause lays out the timeline, clearly outlining when equity is earned over the vesting period with cliff period clearly defined. It protects against early exit with significant equity.
   • For ensuring founder’s and investor’s commitment to the company restriction may be placed on exit.
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4. Shareholding
   • For protecting ownership of the company, manner of transfer and ownership of shares should be clearly laid out. For the same, some clear rights include:
     1. Right of first refusal (ROFR): It forces a shareholder, desirous of exiting, to first offer the shares to existing shareholders and only after refusal from existing shareholders, can the shares be offered to a third party.
     2. Tag-along right: It protects minority shareholders by giving them the right to sell their shares, in case majority shareholders sell their shares, at the same terms and conditions.
     3. Drag-along right: It protects majority shareholders by giving them the right to force sale shares of minority shareholders along with sale of their shares, when they find a buyer of the company.

5. Economic calculation
   • Liquidation Preference: The 2 options that exist are non-participating and participating. The first option is fair to the founders as the investors would get their money back or their share percentage, whichever is higher, unlike the latter option, wherein the investor gets both.
   • Anti-dilution: In cases where the next round of fund raising is at lower valuation different formulas can be used to adjust the stake of preferred shareholder.
     1. Broad-Based Weighted Average: It protects preferred shareholder by adjusting conversion price less severely based on the next round. This is preferred method to protect, especially founders.
     2. Full Ratchet: Conversion price matches the price of next round.
   • Dispute resolution: To minimize costly litigation a clear dispute resolution mechanism should be laid out like negotiation, mediation then arbitration. Under Arbitration and Conciliation Act, 1996, the seat, language, number of arbitrators, appointing authority, and governing law should be spelled out.
   • Exit: The agreement should clearly layout how a termination is triggered. These events that trigger exit, include IPO, M&A, mutual consent, sunset date, put option, call option.