Any transaction for an equity investment has 3 main agreements. The Shareholders Agreement is essential and lays out the rights and obligations of all shareholders after the transaction is completed. The Share Subscription Agreement outlines the process for a fresh issuance of equity shares by the company. The Share Purchase Agreement has the process when one investor buys out shares from another selling shareholder.

1. Any equity investment agreement usually comprises of the following 3 agreements:

a. Share Purchase Agreement – covers the legal aspects of purchasing shares from a selling shareholder. This agreement is executed only if there is a selling shareholder in the transaction.

b. Share Subscription Agreement – this entails the legal aspects around the process related to issuing of shares by a company. The agreement is executed if a company is raising equity capital as part of the transaction. Issues covered in this agreement include: conditions to be fulfilled before the investor provides capital to the company, the maximum time available to the investor between execution of the agreement and transferring of funds, indemnities offered by the company to the investor, among other items.

c. Shareholders Agreement– this agreement captures the rights and obligations of different shareholders within a company

2. A legal contract in India falls under several legal frameworks in India particular under the Company’s Act and the Contract Law.

3. Some market standards for these legal agreements are mentioned below. Please note that in reality these clauses vary depending on the situation and the negotiating leverage of each of the parties.

Any investor’s approach to a legal contract is the following:

Much of the capital to build the business comes from investors and therefore if a company is wound up or is sold such that only the invested capital is returned then the investors have priority in receiving that capital.

At the time of raising capital, entrepreneurs normally share a business plan and a strategy. After convincing the VC of the lucrativeness of the business plan, the investment is consummated. The VC therefore negotiates ‘reserved matters’ – that is, key issues that are veto items for the investor to decide – this includes items such as new lines of business, business plan for each year, raising capital, divesting any line of business, etc. These items look onerous however they have become market standards because VCs need to be convinced in case there is a deviation from the business plan at the time of the original investment.

“The path to exit for the VC in these legal agreements is usually defined. VCs usually seek to exit within 5 years of making an investment and this is made clear upfront to the entrepreneur. Companies therefore agree to having an exit mechanism for investors. This usually entails something on the following lines:

1) The company will organize an IPO five years after the date of investment.

2) If the IPO does not take place, then the company will organize another buyer for the investor’s shares

3) If both the points above do not go through, then the investors can require the entrepreneur(s) to sell their shares if that facilitates an exit for the investor. This effectively means that the investor can sell the company in order to ensure an exit.”

There is some distinction in the rights an investor gets depending on the stake that is being acquired in the transaction. If the investor is purchasing a stake less than 10%, the investor usually does not get reserved matters related to future fundraises, ability to drag the shareholding of the founders, among others. Between 10-50% ownership the investors tend to get most of the rights mentioned above. Above 50% ownership, the investor(s) owns majority of voting rights and therefore in this case the entrepreneur should negotiate certain reserved matters for himself/herself.

In addition to the above, there are some other agreements that vary from transaction to transaction. For example, there may be an ESOP agreement, an employment agreement for senior management, etc.

 

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