Navigating a Shareholders' Agreement for Family Businesses

Written by

Anuj Shah, Varsha Reddy

Published on

18 December 2024

Indian family businesses have dominated the Indian economy for several decades leading to a history of innovation and entrepreneurship. They are the backbone of the Indian economy and immensely contribute towards nation building and our international standing. They provide employment to millions and house within its fold the grit, hard work and talent of its founders and of the many that contribute to bringing the business to where it stands today. This puts a moral obligation on the succeeding generations to ensure that the businesses continue to grow and prosper. 

However, not all family businesses have achieved the grandest success and there are a few factors that distinguish the truly successful: (a) smooth inter-generational transfer; (b) focus on talent and culture; (c) professionalising the business, where required; (d) clearly laid out business vision, value and mission; (e) harmony between legacy and entrepreneurship, etc.

Why a shareholders' agreement is important for family businesses

While one may think it is easier to navigate issues in a family business as compared to a professionalised company, there are a few guaranteed pitfalls which a family business can easily overcome through a robust shareholders agreement (SHA). Through experience, we have learned that businesses need to ensure (a) there is a defined family legacy; (b) identifying roles of various members; (c) training and qualifications for the next generation; (d) having a dispute resolution mechanism in place; (e) exit from the business, entry into new business ventures, philanthropy, etc. have been thought through. 

In addition to an SHA, a ‘family constitution’ could be a valuable tool that outlines family’s core beliefs, value system to achieve continued growth of the family business. However, a family constitution is generally not legally binding but is a ‘moral code’ and is generally followed up with a legally binding and enforceable ‘SHA’. Generally, every member who is actively involved in the business should be a party to the SHA. The SHA can ensure unity in control while the economic benefits are distributed among the family in the manner desirable. The importance lies in ensuring there is no loss of control over the business by ensuring there are restrictions on transfer and devolution of ownership after a members’ demise as the same would generally lead to fragmentation.

Ensuring governance and clarity in family business roles

If there are two or more siblings or cousins involved in the business, it becomes important to ensure representation on the board of directors or equitable management rights. If desirable, specific verticals may be identified to be managed by each branch. Identification of economic and management rights of the next generation leads to clarity of roles and ensures disputes are mitigated. Many families have now prescribed specific qualifications for the next generation to enter the business. 

While these are difficult aspects to contemplate, clear terms of exit must be identified to ensure the exiting branch is compensated economically while the continuing branch of the family retains control and management of the business. If family funds are to be utilised for new business ventures, criteria may be laid out for such investments including non-compete provisions. 

Most importantly, an internal dispute resolution process should be identified to ensure that the family conflict does not become a public matter which leads to value erosion. It is also imperative to ensure that the principles agreed upon in the SHA are enshrined in the charter documents of the business entity. We would also recommend incorporating a strict confidentiality clause to ensure that the rights and obligations of the parties are not publicly disclosed.

While it is commonly misunderstood that SHAs for publicly listed entities are not permitted, there are still some aspects that may be governed through a SHA subject to a disclosure requirement. Alternatively, one may also explore family constitutions, which govern key principles of management and ownership of the family business that do not directly impact the underlying entities. 

Planning for long-term success

Ultimately, there is no one-size-fits-all solution for family businesses. Different strategies may be adopted depending on the succession objectives of each family, size and business verticals. However, what is of prime importance is planning (and planning early!) for the unforeseen. A well written family constitution along with a binding SHA may save many family businesses from endless conflicts and help safeguard value.

world's largest law firm help you today

How can India's leading law firm help you today?