In our previous post we had explained the relevance of a shareholder’s agreement. In this post, we will further explain how are company management rights determined and negotiated in a shareholder’s agreement.
What does management rights mean?
Under Indian laws, the Board of Directors of the company are vested with the judiciary responsibility for the management of the company. The Board of Directors of the company are appointed by the Shareholders of the company. In the process of infusing funds, the investors tend to agree with the Founders about the composition of the Board of Directors of the company as a part of the shareholders’ agreement.
Composition of the Board
Under the shareholders’ agreement, the investor may wish to impose a maximum number of people who shall constitute the Board of Directors. In certain cases, along with the number of directors, the investor may also define the composition of the Board i.e. the investor may provide that 50% of the members of the Board of Directors shall be represented by the investor. Usually, the composition of the Board is imposed by the investors only when they tend to become significant minority (49%) holders of the company.
Appointment of Observer to the Board
Where investors do not intend to hold equity shares in the company, they may tend to appoint a Board Observer, who shall not have a voting right but shall be present in each and every meeting of the Board of Directors. The appointment of Board Observe is usually limited by the percentage stake held by the investor in the company on a fully diluted basis. The Investor may agree that the power to appoint a Board Observer shall vest with the Invest till the time the investor holds at least 10% in the company on a fully-diluted basis.
Understanding percentage held on fully diluted basis with an example
Shareholding on fully diluted basis means converting all the securities issued by the company, other than equity shares, and counting the stake held in the company by each person assuming the securities have been completely converted. For example: Founder holds 100% equity shares in a company. Investor holds 1,000 compulsorily convertible preference shares (CCPS), which entitles the investor to hold 20% shares of the company. On a fully diluted basis, the stake of the company is Founder 80% and Investor 20%.
Apart from the statutory requirements to hold board meetings, the investors through the shareholders’ agreement require that the board shall hold meetings at least ‘X’ number of times each year. Specifying such number of board meetings help the investors to keep regular track of the progress and business operations of the company.
This post is part of our Founder’s handbook – “Negotiating Shareholder’s Agreement”, a comprehensive handbook for founders to negotiate shareholder’s agreement. Click here to download the complete handbook.
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