Subscription Agreement

What legal documents are needed for an investment transaction?

Investing in a private limited company can be documented in various ways, often driven by commercial or personal preference rather than solely legal considerations.

The main decision lies between:

• a combined Investment and Shareholders Agreement (abbreviated as an ISHA)
• separate forms of Investment/Subscription Agreement and Shareholders Agreement

Having separate forms of Investment/Subscription Agreement and Shareholders Agreement may be more suitable for a company:

• which already has non-management shareholders or investors, perhaps as a result of a previous investment round
• which anticipates having future funding rounds

The Investment/Subscription Agreement (or the investment sections of a combined ISHA) will document the specific terms for the current investment and warranties for the benefit of the investor.

The Shareholders Agreement (or the shareholders agreement sections of a combined ISHA) will govern the relationship between the company and all of its shareholders going forward.  In subsequent investment rounds, investors who are new shareholders become bound by the Shareholders Agreement by adhering to it.

What are the main terms of a Subscription Agreement?

A Subscription Agreement is the document under which an investor agrees to invest for shares in the company, usually for cash.  Its main terms are typically:

• subscription: the mechanism and terms for the subscription for shares
• conditions: any conditions to be satisfied as pre-conditions to the investment
• completion: completion (also referred to as closing) of the investment, including issue of shares to the investor and payment by the investor
• warranties: warranties from the company and possible the founder shareholder(s) relating to the company, its business, its financial performance and prospects, assets, contracts, rights and liabilities
• limitations on liability: legal limitations on the potential liability under the warranties of the persons who have given the warranties. These limitations usually relate to:
  • specific exceptions to the warranties which have been disclosed in the Disclosure Letter
  • time limits within which a potential claim may be brought under the warranties after completion
  • exemption from liability under the warranties for small claims or for claims within an agreed basket amount
  • aggregate potential liability for the warrantors together and for each warrantor up to a specified amount

A subscription agreement for a start-up company is likely be shorter and on more straightforward terms than a subscription agreement for an established business.

What are the main terms of a Shareholders Agreement?

The Shareholders Agreement will govern the relationship of the investor and the existing shareholders going forward following completion of the investment.  A Shareholders Agreement for an investment transaction covers a lot of the same issues as any other shareholders agreement between business partners or joint venture partners, except that the rights are more tailored and worded towards being for the benefit of the investor.

The usual matters covered in a Shareholders Agreement for an investment (and assuming that the investor is a minority shareholder) include:

• specifying the business of the company
• confirming the shareholders and shareholdings, including any granted share options or share option pool
• how the company will be funded if further funding is required
• investor’s right to appoint a director and/or an observer to the board
• how proceedings of the board will be conducted
• shareholder rights to dividends
• process for the issue of further shares, including pre-emption rights in favour of the investor
• process for the transfer of shares, including pre-emption rights in favour of the investor
• matters requiring the prior approval of the investor (“reserved matters”)
• investor’s rights to information about the company and its finances
• restrictive covenants on the founders/executive shareholders