Shareholders' Agreement
Also written SHA · Shareholders' Agreement (SHA)
An inter se agreement between an AIF and all existing shareholders of the investee company, binding them to the rights and obligations of the deal — made enforceable by amending the articles.
In plain language
An AIF that buys 20% of a company cares a great deal about what the other 80% can do. Can the promoter sell out to a stranger? Must he offer his shares to the fund first? Can he be made to sell alongside the fund on exit? The company cannot promise any of that; only the shareholders can.
That is why the definitive agreements include a Shareholders' Agreement. The workbook describes it as "an inter-se agreement among shareholders which is intended to make them agree to the rights and obligation stipulated under the agreement". It is entered into between all the existing shareholders of the investee company and the AIF, and the company is made a party where clauses need privity of contract with it.
The need arises because the equity investment conditions in the share subscription agreement "are binding only on the company and not on its shareholders since they are not a party to it".
How it works
What typically lives in the SHA. The workbook places the exit rights here expressly — Right of First Refusal (ROFR) and Right of First Offer (ROFO) "are contractual terms between shareholders which are provided in the Shareholders' Agreement", arrangements inter se that "do not affect the company as such". Tag along and drag along rights, often combined with a lock-in on promoter and key-manager shares, are built the same way.
Making it enforceable. The articles of association of the investee company are amended to incorporate the provisions of the new shareholders' agreement so that it is enforceable.
Conflicting agreements. If a shareholders' agreement already exists, care is needed so that there are not multiple SHAs with conflicting provisions. The existing agreements are amended to bring all shareholders on a common footing, and usually the latest agreement with all shareholder signatures supersedes all previous ones.
When it is folded into the SSA. Where the promoter owns all the shares or controls the other shareholders, a combined share subscription agreement incorporating the SHA provisions may be entered into.
Associated documentation for the transaction may also include management contracts with the key management team, additional financing agreements and undertakings or declarations from founders or principal shareholders.
A worked example
Illustrative figures. Konkan Ventures Fund invests Rs 45 crore for 18% of Silvassa Polymers Pvt Ltd. The existing shareholding is:
| Shareholder | Stake before | Stake after |
|---|---|---|
| Founder, Mr Patil | 60% | 49.2% |
| Mrs Patil | 15% | 12.3% |
| An earlier angel investor | 25% | 20.5% |
| Konkan Ventures Fund | — | 18.0% |
(Each existing stake is diluted by the same factor, 82 ÷ 100.)
Silvassa Polymers signs the SSA. But the fund also needs Mr Patil not to sell to a competitor without offering his shares first, and needs the right to sell alongside him if he does. Neither the company nor the SSA can deliver that, so the fund, all three existing shareholders and the company sign a Shareholders' Agreement carrying a ROFR and a tag along on the founder's shares.
There is a snag: the angel investor already has a 2023 SHA with the Patils giving him a first right of refusal. Two SHAs with competing ROFRs would conflict, so the 2023 agreement is amended and the new SHA — signed by all four shareholders — supersedes it. The articles are then amended so that a transfer in breach of the SHA can be refused by the company.
Why NISM asks about it
Chapter 7 (Investment Process and Governance of Funds) sets out the Shareholders' Agreement at 7.3 among the definitive agreements, with its parties, its purpose and the problem of conflicting agreements, and returns to it at 7.4.6 as the home of the exit rights. Expect questions on why the SHA is needed when an SSA exists (the SSA binds only the company), who the parties are, how it is made enforceable (amending the articles), and which rights live in it.
Common exam traps
- The SHA binds shareholders; the SSA binds the company. Questions describe the SHA as "an agreement between the AIF and the company only" — that is the SSA.
- All existing shareholders and the AIF are parties; the company joins where clauses need privity of contract with it.
- ROFR and ROFO are arrangements inter se between shareholders and "do not affect the company as such".
- It is made enforceable by amending the articles of association — not by filing it with SEBI.
- Multiple conflicting SHAs are cured by amendment, and usually the latest agreement signed by all shareholders supersedes the rest.
- A combined SSA-cum-SHA is used only in particular cases — where the promoter owns all the shares or controls the other shareholders.
Where this is taught
Free preparation for NISM Series XIX-ARelated terms
- Definitive AgreementsThe binding agreements signed between an investee company and the investment manager representing the AIF to complete an investment — chiefly the share subscription agreement and the shareholders' agreement.
- Drag Along (Bring Along) RightAn exit right obliging other shareholders — typically the promoters — to sell their shares to the same buyer on the same terms when the AIF holding the right chooses to sell.
- Share Subscription AgreementThe main definitive agreement between an AIF and an investee company for a fresh issue of shares — setting the terms of the investment and the AIF's rights beyond an ordinary shareholder's.
- Tag Along (Co-sale) RightAn exit right letting the AIF insist that anyone buying a promoter's shares also buys the same percentage of the AIF's shares, at the same price and on the same terms.
- Right of First OfferA shareholders' agreement right requiring a selling shareholder to obtain the holder's best offer first, and to sell to the holder at that price if the market cannot beat it.
- Right of First RefusalA shareholder right to match the best outside quote a selling shareholder has obtained — the holder sees the price first and may buy at it, or refuse and let the sale proceed.
- Final Investment MemorandumThe memorandum a PE fund's deal team prepares once the investment committee gives final approval, proposing a specific valuation — which the start-up can still negotiate before final agreements are signed.
- Term SheetThe non-binding document in which an AIF and an investee company set out the main terms of a proposed investment. Once signed, it leads to due diligence and then to the binding definitive agreements.
- Capitalization TableThe record of who owns how much of a company — every class of shares, each investor's stake and the employee option pool. An AIF's name goes on it when the shares are allotted.
- Protective provisionsTerm-sheet rights letting a class of preferred shareholders — usually minority or preference investors — approve key company decisions such as new share classes, board size, dividends or dissolution.
- Affirmative RightsInvestor protection rights under which specified corporate actions of an investee company need the AIF's express consent, whatever the size of its shareholding — described as "positive control".
- Veto RightsAn investor's right to block a corporate action of the investee company even when it has the requisite majority — "negative control", as opposed to the "positive control" of affirmative rights.
- Disclosure LetterA document the investee company issues to the AIF alongside the Share Subscription Agreement, listing exceptions to its warranties so disclosed risks shift from the promoters to the AIF.
- Ratchet (Clawback) ClauseAn anti-dilution clause that hands an existing investor extra shares, free or near-free, if the company later raises money at a lower valuation — compensating it for having paid too much.