The short answer
In a minority stake deal, the shareholders' agreement, or SHA, sets out how the company will be governed after the investment and how each side can leave. An investor holding a minority uses it to secure information, a board seat, a veto on major decisions and a route to exit. A promoter uses it to keep day to day control and to stop those protections from turning into a stranglehold.
The situation
A Rajkot auto parts promoter is selling a minority stake to a private equity fund to pay for a new machining line. The fund will hold less than half the shares and the promoter family will keep the rest. The fund's first draft SHA lists thirty reserved matters, gives the fund a right to force a sale of the whole company after five years, and requires monthly reporting within ten days of month end. The promoter wants to know which terms are normal and which he should push back on. The fund, for its part, needs enough protection to justify investing without control.
How the SHA relates to the company's articles
The SHA is a contract between the shareholders and usually the company. Under the Companies Act, 2013, the articles of association govern the company's internal affairs, and rights that are not reflected in the articles can be harder to enforce against the company. For that reason, lawyers usually amend the articles to include the key SHA terms when the investment closes. Changes to the articles need a special resolution and a filing with the Registrar of Companies on the MCA portal.
Governance
Board seats
A minority investor commonly gets the right to nominate one or more directors while it holds a set percentage, and sometimes an observer seat. The promoter usually keeps the right to appoint a majority of the board and the chair. Agree what happens to the investor's seat if its holding falls below the threshold.
Reserved matters
These are decisions that need the investor's consent, either at board or shareholder level. Reasonable lists usually cover:
- changes to the share capital or new share issues
- changes to the articles or the nature of the business
- mergers, acquisitions, sales of major assets and winding up
- borrowing above an agreed limit
- related party transactions
- appointment or removal of the chief executive or auditors
- approval of the annual budget, in some deals
Promoters should resist reserved matters that cover routine operations, such as hiring below a senior level or ordinary purchase orders. A long list slows the business and invites deadlock. Related party transactions also have their own approval rules under the Companies Act, 2013, which the SHA adds to. See related party transactions in diligence.
Information rights
Monthly or quarterly management accounts, audited annual accounts, the budget and notice of material events. Set realistic timelines for a business that closes its books in Tally with a small finance team, and agree a standard format early. Our guide on post deal reporting and the first board pack shows what a workable pack contains.
Transfer of shares
Lock in and transfer restrictions
The investor will usually want the promoter locked in for a period, so the people it invested in stay. The promoter may ask for a shorter lock in on the investor, or limits on transfers to competitors.
Right of first refusal or first offer
Before either side sells to an outsider, the other may get the right to buy first, or to make the first offer. These rights protect each side from an unwelcome new shareholder.
Tag along
If the promoter sells shares to a third party, the investor can join the sale on the same terms, so it is not left behind with a new majority owner it did not choose.
Drag along
The holder of a drag right can require the other shareholders to sell alongside it, so a buyer can acquire the whole company. Investors often ask for a drag right that applies if no exit has happened by a set date. For a promoter, this is the clause to read most carefully: agree a minimum price or return, a period before it applies, and a right for the promoter to buy the investor out first.
Exits
The SHA usually lists the routes by which the investor expects to exit, in order:
- an initial public offering within a target period
- a sale to a strategic buyer or another investor
- a buyback by the company or a purchase by the promoter
Where a promoter purchase or a buyback is involved, the Companies Act, 2013 rules on buybacks, and where a non resident investor is involved, the pricing rules under FEMA, 1999 limit how far a guaranteed return can be built in. See foreign investment in an Indian company. Put options that promise an assured return to a foreign investor are a specific area to check with your lawyer.
Other protections
Anti dilution
Protects the investor if later shares are issued at a lower price, usually by adjusting its holding. Broad based weighted average protection is more common than full ratchet in negotiated deals.
Pre-emptive rights
Lets each shareholder take up new shares to keep its percentage.
Deadlock
A route for decisions where the board or shareholders are stuck: escalation to principals, a cooling off period, mediation and, as a last step in some deals, a buy sell mechanism.
How the Rajkot promoter negotiates
In this sample case, the promoter accepts one investor director and an observer, and a reserved matters list of about a dozen items focused on capital, structure, borrowing and related parties. The drag right is accepted, applying only after a set period and above a minimum price, with a promoter right to buy the fund out first at that price. Monthly reporting moves to twenty days after month end in an agreed format. The fund gets the protections it needs, and the promoter keeps running the plant.
Where Synerger fits
Synerger holds the term sheet, each SHA draft, the amended articles and the board approvals in one record, with comments on each document and a decision log that shows how each clause was settled. The templates library includes sample heads of terms and deal structure templates for discussion. After closing, engagements and reporting tools help the promoter meet the information rights on time.
General information; have your lawyer draft the SHA and the matching changes to the articles.