This article is written by Shambhavi Singh, from Bharti Vidyapeeth. She is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.com. Here she discusses “How to draft a share subscription agreement”.
The share subscription agreement is one type of share offer document. It is also known as a two-way guarantee, the subscriber agrees to purchase shares at a fixed price while the company agrees to sell those shares. It is an exchange of promises between a shareholder(subscriber) and company. Mostly it is preferred by startups after the terms laid and negotiated on a non-binding document, term sheet.
The core objective of the share subscription agreement is to have a firm commitment with regard to share subscription and to have a clear agreement with shareholders. Share subscription agreement sets out the mechanics of investment, made by the investor into the company. It binds the parties to execute the investment process. The terms in it can be investor-friendly. One of the alternatives of share subscription agreement is share subscription letter, it sets out the principle terms but does not contain the warranties of company or founder. The startups will like to reconsider whether they need this agreement or share a subscription letter will suffice.
Disadvantages
Disadvantage
Recitals: it holds the basic information like the company is engaged in which kind of business, the issued subscribed and paid capital of the company, how the consideration will be paid for the subscription of shares, percentage of acquisition by the investor, the face value of shares, about the term sheet.
That the subscriber is not entering into the agreement with the knowledge that has not been publicly disclosed (insider trading), the subscriber has received all the relevant documents of the companies.
The subscriber can ask to meet their financial commitment and fulfil their obligations under the agreement.
The investors in all possible ways will make a specific demand for what they want to be represented, nothing should come as out of blue after the negotiations and term sheet agreement.
The warranties in the share subscription agreement can be wide as it may contain that all the known information to the founders and directors has been delivered to the investor. Promoters are not aware of any excess information except what is being told to the investor that may affect the investment.
The company can enter into agreements, it may also include the warranty that it owns certain license or intellectual property rights.
Condition precedent can be any terms and conditions laid by either of the parties that need to be fulfilled prior to the agreement coming into force. This can be certain activities that need to be done by the subscriber or on behalf of him before the execution of the agreement or it can be passing of the relevant resolutions by the director of the company.
This clause is put so that the confidential information is not revealed to any third party without the prior consent of the company in writing as the clause speaks for itself. Both parties agree to be bound by a mutual confidentiality clause.
This clause may have exceptions like revealing the information by a party to any of its representatives or disclosure after obtaining the consent in writing etc.
The inscription laid out in the term sheet is jotted down here to give it the final touch. The terms in the term sheet outline the agreed “conditions” for an investment. The conditions would involve terms like:
Investment amount
Pre-money valuation
Post money valuation
Conversion right: A conversion right is the right to convert shares of preferred stock into shares of common stock. (Optional or mandatory)
Option Pools
Liquidation preference shares: The liquidation preference sets out who gets paid first and how much they get in the event of a liquidation, a bankruptcy or a sale. This is the preference given to investors to get their money back first then to other stakeholders and debt holders at the event of liquidation of the company. This clause should be put in very carefully as to whom the preference is given while liquidation of the company.
Drag along with rights
Dividends: paid on a regular basis or accumulated?
Investor protection rights : Anti-dilution clause
Pre-emptive or pro-rata rights
Investors’ Right of the First Refusal- In case founders intend to exit the company due to some event, then investors should have the right to first purchase the stake of founders. The founders can not exist before the lock-in period if there is a clause to that effect in the term sheet. This clause protects the interest of investors.
Duration of the stake- in this clause the investor will ensure that he ll keep his investment in the company and he will not revoke it up to a certain number of years (3 to 5 years)
No- shop clause
Tag-along rights- this clause is put to save the interest of minority shareholders so that if majority stakeholders are selling their stake then minority stakeholders can join the deal and sell their stake in the company. It puts the contractual obligation on majority stakeholders to include the minority shareholders. This clause gives a sort of protection to the minority shareholders and it should be there in order to protect the interest of minority shareholders.
Redemption rights
. Exclusivity
. Confidentiality
Any of the party will indemnify the other party against any losses, claims, costs, liabilities, damages occurred if any party is in breach or damages occurred because of inaccurate information in the warranties and representation clause .it is a bit time taking process and costly.
Procedure for indemnification is as follows:
The agreement shall be executed by both the parties from the date of execution. The agreement may be terminated in a few different ways described here:
The leverage of remedy is given to both the parties but on some considerable facts.
If any non-performance of any obligation occurred by the investor then the company may-
Company founders representatives: generally the first founder of the company is appointed as agent and attorney for every founder. The first founder can act on behalf of each of the founders in respect of any right, waivers or amendments to be executed by other founders.
Benefits of the agreement: nothing in this clause shall constitute the parties to form a partnership.
Amendments and waivers: validity of amendments will be considered when it is in writing and executed by the party. No waiver shall be effective unless in writing and signed by the party.
Notices: notice or any form of communication in connection with the agreement shall be in writing and personally delivered to their address.
Waiver of the rights/liability: waiver of rights can be given by the company. The liability can be waived, compromised of the parties.
Costs: this clause talks about who will bear the accountancy costs, legal expense and several other expenditures.
Severability: each of the obligation under the share subscription agreement shall be treated as a separate obligation and shall be severally enforceable.
Specific performance: this is the unique clause as parties in this agreement may have a specific performance with or without damages as a remedy.
This clause talks about the jurisdiction of the court and which governing law will prevail.
Any dispute or any question regarding its existence, validity or termination, can be first to be resolved amicably.if the matter remains unsolved then same can be referred to arbitration and the seat of arbitration can be fixed by the parties involved in the agreement. The award shall be binding to both the parties.
There may be n number of the arbitrator and their appointment can be done by done founders, directors, court. The cost of the arbitration can be borne by any party as the agreement says.
This clause deals with the expenditure of stamp duty, either of the parties can agree to bear it. Stamp duty differs from state to state.
The complexity of any agreement leads to the dubious thought that’s why the agreement should be as simple as possible. Like it can be mentioned about the fact that the investor has read the private placement memorandum rather than repeating it.
A finance expert lawyer is the need of the hour for the parties as they can explain all the legalese of the contract and they make sure you agree with the clauses in it.
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