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Shareholder Agreement : A double edge sword for Indian entrepreneurs

Shareholder Agreement - A double edge sword for Indian entrepreneurs

We all know how badly financial crunch has hit the world in the recent half decade. Organizations, big or small, are finding it hard to balance the act of sourcing funds. Any organization can fund sources either internally from owner’s equity or borrowing. Borrowing does not come easy on businesses as they have to pay back in one way or the other. Publicly listed companies are even in deeper trouble when they cannot raise their funds by issuing shares when they have already hit their limit of authorized capital. Venture capitalism is often the last respite in these kinds of situations. However, when we are talking about public listed companies, things are not that simple black and white as they are in other forms of business like in partnerships or private limited companies. Let us look at the trickery of this treacherous path of raising funds using venture capital.

Control on Business Decisions
One of the key concerns that every intelligent entrepreneur should have in mind is giving too much decision authority to the investors. When they take capital from investors, they should never give them way too much power beyond their control. Therefore, one of the primary reasons why entrepreneurs should be wary of taking investments from investors is decision making ability. They have to strike a balance where the will of the shareholders is not entirely compromised because of the new investors entering the business.

Investor Covenants
Sometimes, covenant or conditional investments are made, whereby the conditions do not entirely justify the investments. These conditions may differ as per the industry and regulations but even then, these covenants dictate terms to the entrepreneurs. Entrepreneurs taking investments from investors must always keep in mind that these conditions can become a lot of burden on the business to fulfill. At times, shareholder value, decision making ability, and exercising of free will, everything is affected due to investment covenants. Therefore, whenever an investor or investors attach investment covenants, prudence needs to be exercised in these kinds of circumstances.

Precedent for Other Investors
The first time an entrepreneur goes for an investment from outside, he has to be very carefully not to set wrong precedents. If the investor has attached too many conditions with the investment made, then this would set a wrong example. Other investors brought to business will expect the same types of favors and conditions attached to their investments as well. Therefore, the first investment taken must be considered while keeping all future repercussions in mind. The entrepreneur must negotiate intelligently in order to ensure that his company’s shareholders have no compromise on their interest in the company or their shareholder value has not danger of depletion in case things do not turn as per the business projections.

Personal Liability of Promoters
Promoters must not have unlimited personal liability that they cannot fulfill in case of default. The promoter can be held accountable as an agent or trustee. There are no secret profits allowed for the promoter. The personal liability created by the promoter for the company must be fully disclosed. The promoter cannot hold any other rights except what the law has permitted.

Information Disclosure
Information of every company private limited or publicly listed is highly confidential in nature. The investors must be clearly communicated about the limitations that they have on access to company information. There are many types of critical information that they want to access including books of accounts, financial data, or other confidential agreements. It is very important for the entrepreneur to set clear expectations for the investors so there is no ambiguity. An unchecked access to all information is not desirable as the investor may reveal some critical information to public that can compromise the interest of shareholders.

Investment Horizon and Exit Rights
Company must clearly define the actions that it will take in order to ensure that investors will have profit and when can they exit the company. The investment horizon varies from one company to another. The requirement of investor’s capital to remain with the company depends on the economic as well as the individual company circumstances. A lot of investors usually stick with companies for periods between 3 to 5 years. Usually in this length of time they are able to make handsome amounts of profits over their investments. The shareholder agreement must clearly determine the length of time for which the investor’s investment will remain in the business. This gives shareholders an idea as to how long will their company owe the investment to the investor from outside. Clear instructions must be put in writing about the exit rights of the investor to uphold and protect the interest of shareholders in the company.

Shareholders VS Investor – Important Considerations for Entrepreneur
Shareholders are the real owners of the company. Their right to all profits comes first. Shareholders are the ones who found the company and have real ownership into the company unless they surrender their right of ownership by transferring it to someone else. Therefore, shareholders are the prime stakeholders in all company affairs. Venture capitalism is not an easy thing to consider for any entrepreneur. A true businessman is always looking for opportunities to expand the business. Economic uncertainties may sometimes disturb the cash flow that business has to receive. There are other times when financial crisis of financial institutions may also require an entrepreneur to consider other avenues of gathering funds. In business world there is no such thing as “Free Lunch”. Even investors at times put forth conditions of funding an organization that are unacceptable. Investors have their own interests while investing in a public limited company. Some investors are looking for profits only while others may have higher aims of eventually getting control in the company by acquiring significant amount of shares. Whenever an entrepreneur is considering venture capital for his company he has to balance his shareholders interest with the investment gains. The entrepreneur must also consider any potential problems that may arise due to inclusion of a venture capitalist. A true entrepreneur always considers all aspects of venture capitalism before inducting any outside investor’s investments into his company to ensure that his shareholder’s interest has been protected at all times.

"This is a Guest Post by Mr. Fahad Zahid from Net Lawman Ltd., UK."

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