• Team Law Within

Consequences of not having a shareholders’ agreement in a startup


INTRODUCTION

Most of the start-ups tend to focus only on their business idea and growth during the initial days and often overlook the preventive measures which if taken during this stage could help cope with the problems which may arise in future. One such preventive measure which a startup should resort to is the shareholders’ agreement (SHA).

WHAT IS A SHAREHOLDERS’ AGREEMENT?

SHA is a legal agreement entered between the shareholders of the company, in order to ascertain the rights and obligations of the shareholders and also to set forth the manner in which the company is to function. This agreement has certain key aspects, such as-

  • It covers the rights and obligations of the shareholders along with that of investors and company management.

  • The parties to this agreement are the shareholders, investors and the company

  • This agreement contains clauses dealing with consent, dispute resolution, restriction against transfer, buy-out rights etc.

  • It also helps in ascertaining the way in which the shareholders would take important decisions for the company and the method by which the shares of the company will be valued.

WHY IS IT IMPORTANT TO HAVE A SHAREHOLDERS’ AGREEMENT?

Most start-ups in India are incorporated with friends or known people as shareholders, hence they feel they do not need a SHA, as the relation they share goes way back, however it is prudent to have a SHA because of a twofold reason; firstly it acts as a preventive measure and ensures even the gravest problems are dealt in an efficient way, secondly it helps by reducing the burden of the shareholders as it establishes the core values and rules for the start-up. In addition to this a SHA has certain important features because of which it is advisable to have it even for startups. These include-

  • The SHA acts as the basic constitution for the startup along with the Article of Association for it provides the rights and obligations along with the manner in which the company is to operate,

  • It helps in maintain a cordial work environment by solving disputes between the shareholders and the company,

  • It ensures that the basic rules of governance are formulated and complied with so that the shareholders of the company could single handily focus on the growth and development of the startup.

  • In addition it also provides how the startup would be sold in liquidation, how the IPR of the startup are to be protected and what are the roles to be undertaken by each shareholder along with the mechanism in which the decision making is to take place.

DRAWBACKS OF NOT HAVING A SHAREHOLDERS’ AGREEMENT

A SHA does not provide a concrete solution to every problem nor does it prevents it from taking place but it definitely provides the mechanism to cope with the same. Hence it is imperative for a startup to have a SHA in order to deal with unforeseen situations, some of them being-

  • The founder leaves the company;

  • Need for a new partner;

  • Deadlock situation;

  • The founder who left is now venturing into a similar project;

  • Shareholders ‘are not delivering the expected and projected results

  • Dispute between the shareholders, etc.

The SHA helps in dealing with all these situations by acting as a guide. In case of absence of a SHA it would be really difficult for the startup to cope with legal uncertainty. Moreover handling such situations without a SHA would not only be time consuming and taxing but would also led to slow growth and in some cases winding-up of the company.


Since the SHA governs the functioning of the company by providing set rules, its absence would hinder the decision making process. Eg- the SHA provides that the key decisions are to be taken by the majority shareholders, in absence of such a rule the decision making would be inefficient and in some cases would even leave to a deadlock.


To sum up, an Indian startup should not only focus on its growth by capturing the market and customers but should also pay attention to the basic legal requirements which are essential for its efficient functioning. One such legal requirement is of a SHA that acts as a backbone of any company including a startup making it imperative to incorporate a business by having a SHA as its absence could lead to great risks.


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