This article is written by Harsh Kedia, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com.
To understand this topic, we need to know what shares actually are. As due to rapid growth of business activities around the globe there is an increase of competition in the market. The first and most important priority of any business is to maximise its profits and this is possible when the scale of business is large which requires high level of investments.
As it is not possible for every promoter to keep investing his own money, therefore in order to bring more investments in a company shares are issued to the public or to the prospective investors. Promoter is the one, who undertakes to form a company with reference to a given object and sets it going and takes the necessary steps to accomplish that purpose. Shares are a part of a company’s capital which are issued to the investors according to the amount they invest. Shares give the investor an ownership in the company. For example, suppose your senior owns a very expensive bat which costs around Rs.10,000. You want to use the bat and for this you are willing to pay him Rs. 5,000. This means that now you both can have an equal right on that bat. Similarly, the company allots shares to the respective subscribers according to the amount they are investing. Through this both the company and the investor are benefited. Company will get the investment whereas the investor will get some rights in the company.
Now let’s have a look on how this transfer of shares are legally owned by a shareholder and what are the types of agreement a company and the shareholders can enter into with the company to make this transfer of money and shares legally binding and enforceable. Though these agreements are not governed by any specific statute, most often the terms and conditions of such agreements are mentioned in the articles of association of the companies. AOA basically is a document which defines the roles and responsibilities of directors, kind of business to be undertaken, means by which the shareholders exert control over the board of directors.
Share purchase agreement
From the name itself we can picture an agreement in which the shares are transferred from one party to another. Shares gives the shareholders (one who holds the shares) ownership in the company and this can be done by purchasing a share from the company or from any existing shareholders of the company. As to make any transfer legally binding it is always advisable to enter into an agreement.
The main purpose of this share purchase agreement is to prove both the parties mutually agreed to the terms and conditions and that how much shares are to be transferred from the seller to the buyer at what cost. This also contains various information relating to the company whose shares are being purchased and the rights which the buyer gets from this. One of the most important things which is mentioned under this agreement is the type of shares which are transferred from the seller to the buyer.
Types of shares in a share purchase agreement
As per section 43 of the Companies Act 2013 there are two types of shares which a company issues to the prospective shareholders. One is Equity shares (as mentioned under section 43(a)) and the other is Preference shares (as mentioned under section 43(b)). Both these shares have their own respective benefits and limitations. In short, the former gives a shareholder a right to take part in the meetings and caste their vote in every resolution placed before the company which we often call voting rights whereas the latter gives a shareholder the right to get dividend from the company and no voting rights except in a few cases.
Is a share purchase agreement legally binding?
For any agreement to be legally binding the first criteria which need to be fulfilled is the offer and acceptance. For example, a company A wants some investment and for this purpose he invites the investors to invest in the company. B an investor who wants to invest in Company A brings 100 crores and in return Company A provides B some shares equivalent to the investment amount. This will give B ownership in the Company A up to some extent. As we can see there was an offer made by the A and it was duly accepted by B and this forms an agreement between these two.
As the investor will want his rights to be safeguarded, he will enter into an agreement with the company which in this case will be the share purchase agreement. Like any other legally enforceable agreements, share purchase agreements will have clauses like party’s name, consideration, warranties and indemnities, conditions precedents, etc. This will help the parties to settle the dispute in future if any between them as this agreement covers all the details pertaining to the transfer of shares.
For better and practical understanding please see the sample share purchase agreement from here.
What is a subscription and shareholders agreement?
Share subscription agreement
It is an exchange of promises between a potential shareholder known as a subscriber and a company. A share subscription agreement provides that the company agrees to sell a specific number of shares at a specific time and price, such that the subscriber becomes a shareholder. In return, the subscriber agrees to buy the shares at a specific time and a specific price.
To run a business the most important thing is capital. Without adequate capital no business can run properly and to ensure the smooth functioning of any business the promoters need to bring the capital from time to time through the available means. For this purpose, shares are issued to the investors in return of the amount invested by them. Generally, share subscription agreement is the first document which a company issues and which plays a vital role for any investor to invest in a company. Through this agreement an investor gets to know about his control, role, returns on investments which he will get after the allotment of the shares. This agreement should be drafted in such a manner which could benefit both the company and the investor i.e. to reduce the risk of the investor and to uphold the powers and roles of the company after the investment.
A share subscription agreement lists down the details pertaining to the shares of the company and at what price the shares will be sold. It gives an investor an overall view about the value of the shares of the company. Typically, a company has two options to raise capitals. They can either go public and issue shares to the public at large or they can invite private investors. In any case the share subscription agreement comes into play which determines the number of shares a company is willing to give to the subscriber and the price at which such shares will be given. Some of the most common clauses incorporated in a share subscription agreement are confidentiality, conditions precedent, warranties, indemnity, etc.
Therefore, we can say a share subscription agreement is a formal agreement which contains the terms and conditions relating to the investor’s investment into the company and which binds both the parties in this investment process.
You can see a sample share subscription agreement from here for better understanding.
Shareholders agreement from the name itself denotes an agreement between the shareholders and the company. As in a paragraph mentioned above, there are two types of shares capitals and accordingly a shareholders agreement is entered into between all the shareholders or between the shareholders of a particular class of (equity shareholders or preference shareholders) shares.
As we know that shareholders are the owners of the company or they get ownership from their investments in the company. Unlike share purchase agreement, the scope of shareholders agreement is much wider. As share purchase agreements just lay down a lawful agreement between the parties about the transfer of shares, Shareholders agreement lays down the rights and other obligations of the parties. It defines the actual relationship of the parties in terms of rights generated by purchasing shares of the company.
Purpose of shareholders agreement
Any investor who is willing to invest crores and crores in any company will definitely expect some kind of rights and authority in that company and for this purpose this agreement is executed. As no one can predict what can happen in future and what kind disputes can arise between the parties, the shareholders agreement plays a vital role in resolving disputes. Not only this agreement helps a majority shareholder but it is also very beneficial for minority shareholders.
The main purpose of a shareholders agreement is to ensure that the shareholders are treated fairly and all the rights which were promised by the company to the shareholders are fulfilled. This agreement regulates the sale of shares and the performance of the company. The main motive behind every investment is to maximise the profits and minimize the losses and limitations. If any investor is investing in a company then he will look at the performance of the company both prior to the investment and post investment. And for this, shareholders agreement also describes how the company will run and make profits. Through a shareholders agreement, the shareholders determine the future shareholders of the company.
Please click here to see the sample shareholders agreement.
Share purchase agreement vs shareholders agreement- Key differences
There are some differences between a share purchase agreement and shareholders agreements. Some of them are as follows:
SHARE PURCHASE AGREEMENT
It is an agreement between the two parties for the transfer of shares from the seller to the buyers
It is an agreement entered into to describe the rights and obligations of the company and the shareholders.
A share purchase agreement is entered into between a seller and a buyer
A Shareholders agreement is entered into between all the shareholders and company or between a class of shareholders and the company.
The main aim of a share purchase agreement is to show how much shares are to be transferred and at what price
A Shareholders agreement is entered into to protect the investment of the investors by defining the rules and regulations of a shareholder.
The scope of share purchase agreement is narrower as it only shows the transfer of shares from the seller to the buyer
The scope of shareholders agreement is wider as it clearly defines what roles, responsibilities and powers a shareholder will get in the company.
From the above paragraphs it can be concluded that each type of agreement whether it may share purchase agreement, share subscription agreement or shareholders agreement are entered into to protect the investor as well as the company from any disputes. Each of these three agreements have their distinctive features. It is not a golden rule that one shall enter into an agreement in order to sell or purchase a share but in order to curb the problems which may arise in future, it is always beneficial to give such transactions a written form i.e. form an agreement.
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