Introduction: With the surge in investment in innovative startups, understanding Share Subscription and Shareholders’ Agreements becomes vital. Delve into the nuances of these transaction documents, exploring conditions, obligations, and rights of founders and investors for a secure legal framework.
As multifarious novel innovative industries emerge constantly, making Indian industries more attractive for domestic and international Investors. Many Investors are interested in investing their valuable funds in growing startups for good returns. Also, Startups which are aiming to expand their business require more funds and startups can raise funds by issuing securities which includes rights and obligations of founders and investors.
To formulate those rights, obligations, and expectations; transaction documents are executed. Although such transaction documents are not legally required to be entered, however, to provide the legal safeguard these documents are executed.
The Share Subscription Agreement and Shareholders’ Agreement are two basic transaction documents. As professionals we should understand the basic terms of the said transaction documents.
The above two agreements prima facie look alike; however, the terms of both documents are different. These documents are either executed independently or jointly.
“Share Subscription Agreement” this agreement is entered between the Company, Founders and Investors. This Agreement prescribes the obligations on the part of the Company, Founders and Investors who agree to perform their obligations on fulfillment of certain conditions.
Under aforesaid agreement, Investors agree to Invest their money into the Company on the predetermined price on completion of certain conditions. Also, there are some basis clauses that we should familiarize with: –
1. Condition Precedent: Condition Precedent means obligations/conditions that need to be completed by the Company, Investor and Founders before wiring of funds into the Company to the satisfaction of the Investors.
2. Condition Subsequent: Condition Subsequent means obligations/conditions that need to be completed after wiring of funds into the Company to the satisfaction of the Investors.
3. Use of Proceeds: This Clause defines the purposes where funds are to be utilized. The Company is not authorized to use funds other than defined purposes. This clause ensures Investors that their funds are used for legitimate purposes.
4. Representation and Warranties: This clause represents that all the statements and facts mentioned in the agreement are true and correct as on the date of entering into the agreement, nothing in this agreement is false. Warranties ensure that if later anything turns out to be false then the affected party will be indemnified by the other party against the losses occurred.
5. Indemnification: This clause provides the safeguard to the Investors against the losses occurred due to the act of the Company and of its founders.
“Shareholders’ Agreement” this agreement is entered between the Shareholders and Company to set out the details of rights and obligations of Shareholders and Company.
Investors become shareholders on allotment of shares to them by the Company after wring of funds. Shareholders’ Agreement is executed between them to set out the details of all rights and obligations. Also, the agreement explains the procedure to resolve the disputes between the Company and Shareholders.
Further the Board Composition, Board & Shareholders Meeting Quorum & Procedure, Founder Lock in period, and Voting Rights, etc. are part of the Agreements.
Now let’s discuss the following clauses that are part of the Shareholders’ Agreement: –
1. Pre-Emptive Right or Pro Rata for Future Financing: This right is available to the existing Shareholders to maintain their ownership percentage in the Company. In case the Company proposes to offer new shares or raise future funding then it is required to offer new shares to existing Shareholders in proportion to their existing ownership before offering to third party. Existing Shareholder have a right not an obligation to accept the offer.
If existing shareholders reject the offer only then the Company can offer shares to the third party on same term and Conditions that was offered to the existing shareholders.
2. Right of First Refusal: If any shareholders propose to sell their shareholding to any third party, then selling shareholders first need to offer their shares to other non-selling shareholders on the same price and term & Conditions which are to be offered to third party.
Non-Selling shareholders have a right to accept or reject the offer at their own discretion. If non-selling shareholders reject the offer, then Selling shareholders can sell the shares to third party.
3. Drag Along Right: This is a contractual right that gives protection to the Majority Shareholders. If Majority Shareholders sell their stake or dilute their shareholding, then they can force the minority shareholders to join them to amicably complete the transaction.
4. Tag Along Right/ Co Sale Right: This is a contractual right that gives protection to the Minority Shareholders. If Majority Shareholders are planning to sell their stake, then they should consider the minority stake for selling negotiations. In other word we can say that if the majority shareholder sells their stake in the Company, then the minority shareholder joins them in selling transactions.
5. Anti-dilution Right/ Minimum Shareholding Right: This right provide shield to the existing shareholders to maintain their ownership percentage in case new shares are issued to third party at lower valuation then valuation on which shares are issued to the existing shareholders. Also, dilution takes place when the number of shares increases in the Company. In this case, new shares are issued free of cost to the shareholder to the extent to maintain their shareholding percentage.
Conclusion: In the realm of startup investments, Share Subscription and Shareholders’ Agreements play crucial roles. Understand the nuances, conditions, and clauses of these agreements to ensure legal safeguarding for both founders and investors. Navigate the complexities of investment transactions effectively with this comprehensive guide.
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