Shareholders & Investment Agreements

A shareholders agreement (SHA) is a contract between the shareholders of a company governing their relationship, rights, and obligations. It covers matters that the Articles of Association may not adequately address, including decision-making processes and reserved matters requiring special consent, board composition and nomination rights, transfer restrictions on shares (right of first refusal, tag-along, drag-along), anti-dilution protections, information rights and reporting obligations, dividend policy, non-compete and non-solicitation obligations, and exit mechanisms. An SHA is not legally required, but operating without one is risky. Disputes between founders, or between founders and investors, are among the most common and most damaging situations a company can face. A well-drafted SHA prevents or manages these disputes.

Both are instruments that convert into equity at a future priced round, but they work differently. A SAFE (Simple Agreement for Future Equity) is not a debt instrument. It does not accrue interest or have a maturity date. The investor pays money now and receives the right to convert into equity at the next qualifying round, typically at a discount or subject to a valuation cap. A convertible note is a debt instrument. It carries interest, has a maturity date by which it must convert or be repaid, and converts into equity at a discount to the next round. SAFEs are simpler and more founder-friendly. Convertible notes give the investor the fallback of a repayment obligation. Indian regulatory considerations (including RBI pricing guidelines and FEMA for foreign investors) affect how both instruments are structured. We advise on choosing and documenting the appropriate instrument.

A share subscription agreement (SSA) documents the terms on which an investor subscribes for shares in a company. Key terms include the number and class of shares, the subscription price and payment terms, conditions precedent to closing (regulatory approvals, due diligence satisfaction, board and shareholder approvals), representations and warranties by the company and the promoters, indemnity provisions, and the relationship between the SSA and the shareholders agreement (which is typically executed simultaneously). For foreign investors, FEMA compliance including pricing, reporting, and sectoral conditions must be built into the SSA. We draft and negotiate SSAs for both founders and investors.

Anti-dilution protection shields an investor from a reduction in their percentage ownership or the value of their investment caused by the company issuing new shares at a lower price than the investor paid. The two common formulations are full ratchet (the investor’s conversion price is adjusted down to the new lower price, giving maximum protection) and weighted average (the conversion price is adjusted based on the weighted average of the old and new prices, which is more balanced). Anti-dilution provisions are standard in venture capital and private equity investment agreements. The specific formulation is a negotiation point between founders and investors, and the choice has a meaningful impact on founder dilution in a down round.

Founder vesting is a mechanism where a founder’s shares vest (become fully owned) over a specified period, typically three to four years, with a one-year cliff. If a founder leaves the company before their shares are fully vested, the unvested shares are typically bought back by the company at the original subscription price or forfeited. Investors insist on vesting because they are investing in the team, not just the idea. If a co-founder departs shortly after a funding round, the investor does not want that departing founder to retain a full equity stake without continuing to contribute. Vesting aligns incentives and protects both the remaining founders and the investors.

Legal due diligence typically covers corporate records and governance (incorporation documents, board minutes, shareholder resolutions), capitalisation and equity history (share issuances, transfers, ESOPs, convertible instruments), material contracts (customer agreements, vendor contracts, key partnerships), IP ownership (whether all IP is properly assigned to the company, not sitting with founders or contractors), employment and HR compliance (employment agreements, contractor arrangements, statutory compliance), regulatory licences and approvals, litigation and disputes (pending or threatened), tax compliance, and data protection and privacy practices. The most common red flags are IP not properly assigned to the company, missing board or shareholder approvals for past transactions, and incomplete statutory filings. We advise companies on DD readiness before they approach investors.

Drag-along rights allow the majority shareholders (typically holding a specified threshold, such as 75%) to compel the minority shareholders to join in a sale of the company on the same terms. This ensures that a buyer can acquire 100% of the company without holdout minorities blocking the deal. Tag-along rights give minority shareholders the right to join a sale initiated by the majority on the same terms and at the same price. This protects minority shareholders from being left behind in a transaction where the majority sells its stake to a third party at a premium. Both are standard provisions in shareholders agreements and are negotiated as part of the overall exit framework.