All about the Share Subscription Agreement

09 Oct 2020 Categories : Latest News

The Authors are, Prof. (Dr.) Chitrapu Kama Raju is Principal IFIM Law College, Bangalore and Abhishek Sharma, is 5th Semester Student (B.COM+LLB) at Chandigarh University, Punjab

What is a Share Subscription Agreement?

A share subscription agreement is basically an arrangement where the agreement is made between the company and the investor that involves the acquisition of ownership in the company by issuance of new share. Acquisition in a company can either involve purchase of existing securities or issuance of new shares. Acquisition by purchase of securities is termed as “Share Purchase Agreement” and Acquisition by issuance of new shares is termed as “Share Subscription Agreement”. Under Share Subscription Agreement (SSA) the company wants to issue new shares so that the founders do not dilute their ownership in the company. It is basically a promise by a potential shareholder, to make payment of funds to a company, in return Company issuing a certain number of shares at certain price. A share subscription agreement must include the number of shares that shall be issued to the shareholder, and the order and manner in which the funds will be advanced. At times the SSA sets out the provisions of a term sheet in a better manner.

Objective

The core objective of share subscription agreement is to have all the points clear regarding the provision of the SSA and to have clear agreement with the shareholders that necessarily sets out the mechanics of investment which is/are made by the investor into the company. The main purpose of this agreement is to bind both the parties to execute the investment process.

When would one use them?

A Share Subscription Agreement would be needed when the company wants to raise funds and more specifically by issuance of shares by not diluting the share of the owners. The utilizes this money for its own needs. Usually, the founders of the company use their own money at the start of the business, but eventually the founders will have to seek money from angel investors, or friends or outsiders who have to be issued shares in return of the investment. If any of the founders sell their shares, a share purchase agreement is executed to record the transfer between the selling founders and the incoming investor. In such cases, the consideration is paid to the founders and that portion of the money is not invested in the company. But when the company is not willing to dilute the already held shareholding by the investors and founders, then an SSA is preferred. It is also preferred at the early stages when the founders do not want to sell their shares so early. At the completion of this agreement, the person subscribing to the shares becomes the becomes the shareholder of the company. This can be done to raise capital either by public offer, or private placement.

Advantages of the share subscription agreement

An SSA is used when the company wants to issue new shares without offering the founder’s own shares. Therefore, mostly SSA is mostly used in every stage of the capital-raising process where equity or instruments convertible into equity are used and money is invested into the company.
Share Subscription Agreement is mostly used when the business is at the starting stage where the founders do not wish to dilute their share.
Share Subscription Agreement is a preferred mode of raising funds for start-ups.
With SSA, one can sell the stock without registration with security and Exchange Commission otherwise it is costly and time-consuming.

Disadvantages of the share subscription agreement

There are no voting rights, one has to trust the promoters and directors for its growth.
Invested amount cannot be given back to the investor.

Common clauses in Share Subscription Agreements

Conditions precedent: This clause is used to clearly law down the conditions that are necessary to make the contract alive and functional. It allows both the company and the investor

The Condition Precedent Clause is generally set out by preparing a schedule which contains all the details of the condition to be meted out.

Confidentiality: This clause states the information that must not be shared to outsiders or to anyone without Prior Approval.

Each Party shall keep all the information relating to the other party, information relation to this Agreement or the transactions contemplated herein (Collectively referred to as the Information). None of the parties shall issue any public release or the public announcement or otherwise make any disclosure concerning this Agreement, without prior approval of the Parties.

Provided however, nothing shall stop the parties to disclose the information required by law.

Restraint against competition: This clause lays down the condition that the investor must not compete with the company in any manner for a minimum period of 5 years after the investors takes back his securities. The time period can vary from agreement to agreement. Generally, this clause is added to safeguard the interest of the company so that the investor does not benefit and compete against the company. The agreement may also contain a Right of Refusal clause, which means that, the company should be given an option to purchase the securities of the investor before they are offered to outsiders.

It is hereby agreed and the investor warrants that he shall not compete with the business carried out by the company after the sale of securities for a minimum period of 5 years, which shall otherwise be considered as a breach of contract and the company shall be compensated in that case.

Tranches: The Tranches clause will set out the details of the deal which can usually be found in the term sheet: How many shares are being issued. Subscription price. Prescribed time limits.
Warranty and indemnity: 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.

How to draft a Share Subscription Agreement?

Conditions Precedent Clause:The Condition Precedent Clause is generally set out by preparing a schedule which contains all the details of the condition to be meted out.
Representation and Warranties: That the subscriber represents that he has received all the relevant information and all the relevant documents of the company where he is investing. The subscriber can even ask to meet financial commitment and meet their obligations under the agreement. The investor also shall make a specific demand if there is any for what they want to be represented. The warranty clause is very wide as it contains all the information provided by the directors and members of the company is true in every sense and all the information delivered to the investor is correct. This clause can also include the warranty that the company owns license or other IPR.
Subscription: This clause shall lay don the number of shares purchased and at what price.
Term Sheet: 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, and Post money valuation
Conversion right: This right means that there may be a right to convert the shares of preferred stock into the shares of common stock. This right is not mandatory but optional.
Drag along with rights: Drag along rights mean that the majority shareholders can enforce their decision on the minority shareholders without looking at their interest.
Right of First Refusal: This clause shall state that at the time when the investor is willing to sell its shares, then the company shall be invited first to purchase the shares and only when the company denies to buy the shares, the investor shall sell such share to outsiders.
Duration of the Stake: Minimum duration of the stake to be held by the investor.
Exit Rights: This clause shall state the exit right in case of breach of terms and conditions.
Indemnity: 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.
Termination: By the mutual consent of both the parties.
By the company- if the investor fails to pay for the share subscription on the completion date or if an investor breaches any terms and conditions of the agreement.
By the investor- if the company fails to provide condition precedent or any breach committed by the company, any adverse change occurs before the completion date.
Any party willing to terminate the agreement on the ground of the clauses mentioned above shall issue a notice to the other party.
Compromise with creditors
Event of default- the agreement can be terminated with an event of default by the consent of the parties.
Insolvency- if the company becomes bankrupt then the agreement shall be terminated.

Governing Law and Jurisdiction: The Agreement shall be governed by all the appliable the Indian law.
Dispute Resolution

In the event of a dispute arising between the parties with regards to the interpretation of this agreement or any default or breach by any of the party, such matter or matters in dispute shall be finally settled by way of Arbitration: -

a. Under [the Rules of Conciliation and Arbitration of the International Chamber of Commerce];

b. there shall be appointed a minimum three arbitrators, minimum one should be appointed by each Party, one shall be the chairman, selected by the other appointed arbitrators and failing agreement by the [Chairman of the International Chamber of Commerce];

c. the language of the arbitration shall be English;

d. the place of the arbitration shall be the place of business;

Stamp Duty: It varies from state to state
Miscellaneous:

Amendments and Waivers: It is hereby agreed that during the term of this agreement none of the terms shall be deemed to have been waived by an act of the parties

Severability: It is hereby agreed that if any provision under this agreement is held to be invalid, unenforceable and illegal, then, in any way that provision shall not affect any other provision thereof.

Entire Agreement: This ……… Agreement dated ……… between …………. and …………. constitutes the entire agreement and understanding of the parties with regards to subject matter and supersedes any prior negotiations or agreements between the two parties to the subject matter hereof.

Common Problems with Share Subscription Agreements

If the details are not sufficiently particularized the Company may be unable to enforce its right to payment of capital. Obtaining payment in the form prescribed is the most common grievance.

The clauses such as vesting, exit mechanism, tag/drag along rights, anti-dilution clause must be uniform in nature.
The parties must be identified correctly
It must be ensured that there is clear mention as to whether the share is issued in demat or physical form
Proper Compliance of FEMA, RBI and Companies Act, 2013

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What is Share Subscription Agreement, available at https://www.sec.gov/Archives/edgar/data/1285735/000119312512387136/d406888dex412.htm (Last Visited 5 August 2020)
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