Private equity (“PE”), venture capital (“VC”) investments and mergers and acquisitions (“M&A”) have gained rapid traction in India over the past decade. This growth reflects India’s upward trajectory and attracts strong interest from domestic and foreign investors alike. A typical PE/VC/M&A transaction involves structuring, negotiations, a term sheet, due diligence, definitive documents, execution and, finally, closing.
What Are Definitive Documents?
At the core of every investment transaction lie the agreements that set out its terms and conditions. These agreements cover the financial, legal and commercial aspects vital to the deal and the ongoing relationship between the parties. We call them definitive documents or definitive agreements.
The key definitive documents include the Shareholders’ Agreement (“SHA”), the Share Subscription Agreement (“SSA”) and the Share Purchase Agreement (“SPA”). This article gives you a clear understanding of the documents that govern a PE/VC/M&A transaction. It also explains the key clauses, their significance and the risks of leaving them out.
Shareholders’ Agreement (SHA)
The SHA captures the arrangement between the shareholders of a company. It sets out their rights and obligations, including anti-dilution protection, liquidation preferences and information rights. It also covers control over operations and management, transfer rights and restrictions, exit strategies and other agreed terms.
A well-drafted SHA keeps shareholders aligned. It supports conflict-free operations and decision-making. It also ensures a smooth transition when existing shareholders exit or new shareholders come in. The SHA can grant the parties rights over and above their inherent rights under law. We will discuss the key terms of a SHA in depth in a separate article.
Share Subscription Agreement (SSA)
The SSA is an agreement between a company, its promoters and its existing and/or incoming shareholders. It lays down the terms for the issuance and allotment of fresh shares or securities by the company. It also governs the subscription to those shares by the investors.
The SSA gives the transaction structure and clear timelines. The issuance and allotment must comply with the Companies Act, 2013 and its applicable rules (“CA 2013”). It must also comply with the Foreign Exchange Management Act, 1999 and its applicable policies, rules, directions and regulations (“FEMA”).
The SSA also lists the actions the parties must complete before or after closing, within agreed timelines. In addition, it contains covenants, representations and warranties on which the investors rely when they invest. Finally, it sets out the remedies available to the parties if anyone breaches its terms.
Key Clauses in the Share Subscription Agreement
Subscription to Subscription Shares
This clause records the agreed number or percentage of shares the company will issue and allot to the investor. In return, the investor pays the subscription consideration. The parties calculate this consideration on the basis of the company’s valuation, which sits at the intersection of law and accounting. The company must obtain the valuation in the form and manner prescribed under CA 2013 and FEMA, as applicable.
Conditions Precedent
This clause lists the conditions the parties must fulfil before closing. Once they meet these conditions, the investor subscribes to the shares and the company issues and allots them. Material findings from the pre-investment due diligence often become conditions precedent.
Common examples include rectifying discrepancies in material contracts, licences and labour compliances. Others cover compliance with applicable laws, completing pending filings or reporting, delivering compliance documents and preparing allotment documentation. The parties may agree on further conditions depending on the nature of the transaction and the company’s business.
Closing and Conditions Subsequent
The closing date is the date on which the parties consummate the transaction, subject to fulfilment of the conditions precedent. On this date, the investor remits the subscription consideration to the company and the parties comply with applicable laws. After closing, the parties may agree to meet additional requirements. They must complete these within the timelines specified for each condition, or for all conditions together.
Share Purchase Agreement (SPA)
Parties most commonly draw up a SPA in an acquisition. It is an agreement between the seller(s) of a company’s shares and the purchaser(s) or acquirer(s). It records the transfer of ownership of shares from an existing shareholder to the buyer.
The SPA sets out the terms of the sale. These include the purchase price, payment terms, representations and warranties, and the conditions the parties must fulfil before the buyer purchases the shares. Through the SPA, the title to the shares, their beneficial ownership and any attached risk pass from the seller to the buyer. All associated rights and benefits attached or accrued to the shares pass along with them.
Key Clauses in a Share Purchase Agreement
Purchase and Sale of Sale Shares
This clause captures the number of shares the seller offers for sale or transfer. It also records the consideration payable to the seller and the mode and manner of payment. As in a SSA, the parties arrive at the sale consideration on the basis of a valuation report. The seller must obtain this report in the form and manner prescribed under CA 2013 and FEMA, as applicable.
Conditions Precedent
This clause captures the buyer’s obligation to purchase the sale shares, subject to the fulfilment, waiver or deferral of certain conditions. Material findings from the due diligence report that affect the buyer’s interests also form part of this clause.
Although the SPA is primarily an arrangement between the seller and the buyer, the conditions precedent may impose joint obligations on the seller and the company. These include delivering the transaction documents, such as the share transfer deed, resolutions, forms and the valuation certificate. Other conditions cover tax and corporate compliances for the sale shares, procuring requisite documents and obtaining approvals. If the SPA so requires, the seller may also deliver a completion certificate to the buyer once these conditions stand fulfilled.
Closing and Post-Closing Actions
The closing date is the date on which the parties consummate the transaction after fulfilling the conditions precedent. On this date, the title, beneficial ownership and risk in the sale shares pass from the seller to the buyer. Closing actions include executing the transaction documents and share transfer forms, remitting the sale consideration, filing the requisite forms and complying with applicable laws. After closing, the parties must fulfil the conditions subsequent. These may include filing forms and resolutions and completing other legal compliances.
Common Clauses in the SSA and SPA
Shareholding Pattern
This clause discloses the percentage of ownership each shareholder holds in the company. The parties generally disclose the shareholding structure as on the execution date and as on the closing date. The latter reflects the structure after the allotment or transfer of shares to the investor or acquirer.
Standstill Obligations
This clause requires the company to conduct business in the ordinary course between execution and closing. It also lists restricted matters that need prior consent from the existing shareholders or the incoming investor or acquirer. These may include transactions outside the ordinary course of business and material transactions with directors, promoters or shareholders. They may also cover decisions with a material effect, settlements in any litigation concerning the company, or a change of registered office.
Representations and Warranties
Representations and warranties form a fundamental clause in both the SSA and the SPA. However, the clause differs significantly between the two agreements because of the nature of each transaction. Due diligence findings may also appear as representations and warranties in respect of the company and/or its promoters.
In the SSA, the company and its promoters make several representations and warranties. These cover the capital structure, authority to enter into the agreement, the subscription shares and the constitutional documents. They also extend to borrowings and guarantees, legal compliance, pending proceedings, related party transactions, assets, intellectual property, employees and taxation. The SSA may also include the investor’s representations on its capacity to subscribe to the shares and discharge its obligations.
In the SPA, the seller and the company give representations on the title and ownership of the sale shares. These cover any transfers, transmissions or encumbrances, along with the documentation and compliances relating to the shares. They also address the seller’s and the company’s authority, constitutional and corporate matters, charter documents, tax liabilities and financial statements.
Restrictive Covenants
Both the SSA and the SPA may contain mutual confidentiality, non-disclosure and non-disparagement clauses. These covenants prevent the parties from disclosing confidential information or competing with the company’s business. They also bar derogatory statements about the company, its business, operations, directors or promoters. The parties should keep these covenants reasonable. They should extend only as far as necessary to protect the company’s business interests, goodwill and reputation.
Indemnification
Indemnity is one of the most heavily negotiated clauses. It protects the investor or acquirer against any loss, claim, damage or liability arising from a breach of the agreement. It also covers misrepresentation, fraud, misconduct, inaccurate information or negligence by the company and/or its promoters.
The clause further protects the buyer or investor from third-party actions and from events occurring before the closing date. In certain cases, the parties convert due diligence findings into specific indemnity items against identified matters. These secure claims for liabilities arising from infringements or non-compliances by the seller, the company, the founders or any other shareholder.
Governing Law and Jurisdiction
This clause records the parties’ agreement on the governing law and jurisdiction for the definitive documents. It also sets out the agreed process for resolving any disputes arising out of the transaction or the definitive documents.
Conclusion
PE/VC investments and M&A transactions demand meticulous structuring, careful negotiation and thorough drafting of definitive documents. These documents capture the entire investment process, including the rights, obligations and liabilities of the investor or acquirer, the promoters, the shareholders and the company. The SSA records the issuance and allotment of shares by the company directly to the investor. The SPA, on the other hand, records the transfer of title in shares from an existing shareholder to a buyer. Well-structured, carefully drafted and duly executed transaction documents protect the interests of everyone involved — investors, acquirers, promoters, shareholders, directors and the company itself.
Original Source: https://www.ahlawatassociates.com/blog/definitive-documents-pe-vc-ma-transaction
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