A definitive agreement is a legally binding contract that outlines the final, agreed-upon terms of a transaction. In the context of business investments and mergers and acquisitions (M&A), the most common definitive agreements are the Share Purchase Agreement (SPA) and the Shareholders’ Agreement (SHA). While both deal with company shares, they serve different purposes.
These are fascinating times for founders to build scalable businesses in India:
- Sectors are opening up, getting organized and throwing massive opportunities for problem solvers,
- regulations are increasingly getting liberalised,
- technology advancements are providing unprecedented tailwinds.
- lastly and most importantly, capital is easily available across stages of venture building.
As founders pursue these opportunities and raise significant amounts of capital, it is vital to understand that each round of funding involves parting with not only ownership but also a degree of control over the company. While the ownership dilution is usually clear, the implications of control are often underestimated or overlooked.
What are Definitive Agreements?
If you have raised funds in the past or have tracked investments in startups, you would have definitely come across terms like: SSA, SHA, SPA or Definitive Agreements. Let’s aim to demystify these terms in this blog.
Definitive Agreements
In the context of investment, a ‘definitive agreement’ is the final, legally binding document signed by all the parties of the transaction which puts forth the agreed terms along with rights and obligations of the parties involved in the transaction. Some things to note:
- Legally binding document. Typically executed on a Stamp Paper with appropriate stamp duty paid based on the local jurisdiction.
- Signed by all the parties involved in the transaction.
- Most Common Examples: Shareholders’ Agreement (SHA), Share Subscription Agreement (SSA), Share Purchase Agreement (SPA)
- Term sheet is not a definitive agreement. But definitive agreements typically follow the signing of a term sheet.
- Definitive documents are necessary and form the basis of consummating certain transactions such as sale of shares between parties, issuance of shares against investment among others.
- Definitive agreements contain terms of the transaction, right and obligations of parties and many other standard legal clauses which we’ll discuss in this blog series.
What is an SSA?
A Share Subscription Agreement (SSA) as the name indicates is related to subscription of new shares of the company by a set of existing or new shareholders.
SSA is executed when a company is raising an investment from investors in lieu of shares issued by the company to the investors. Such shares are said to be ‘subscribed’ by the investors and hence the name SSA.
- SSA typically consists of the details of the subscription — amount, share price, number of securities, relevant dates and capitalization table (shareholding) details.
- In some cases, SSA can also be integrated within the SHA document which details the other terms of the transaction between the shareholders. In such cases it is typically referred to as an SSA/SHA or also simply as SHA
Purpose:
To formalize the mechanics of an investment where a company issues new shares to an investor.
Key Terms:
- Number and class of shares being subscribed.
- Price per share and total investment amount.
- Conditions precedent (tasks to be completed before the investment is made).
- Representations and warranties made by the company and founders.
- Investor protections.
- Exit strategies.
- Payment obligations for the investment.
What is a SPA?
A Share Purchase Agreement (SPA) is executed between parties when one party is buying or ‘purchasing’ shares from existing shareholders. Hence the name Share Purchase Agreement
Like in case of SSA, sometimes SPA too is part of the larger SHA document and is referred to as SPA/SHA.
Purpose:
- To transfer ownership: It details the mechanics of the sale, including the number of shares being transferred, the purchase price, and the total consideration.
- To protect the buyer: It includes critical protections for the buyer, such as representations and warranties from the seller about the company’s financial status, legal compliance, and assets.
- To set closing conditions: The SPA outlines the conditions that must be met before the sale can be finalized, such as obtaining regulatory approvals.
Key clauses:
- Purchase price: Specifies the agreed-upon price for the shares and the payment terms.
- Representations and warranties: Statements from the seller confirming the accuracy of facts about the company, its finances, and its legal standing.
- Indemnification: A clause that protects the buyer against losses resulting from a breach of the seller’s representations or warranties.
- Closing conditions: Details the requirements that must be satisfied to complete the transaction.
What is a SHA?
Shareholders’ Agreement is a comprehensive definitive agreement entered into by shareholders and the company and outlines the rights, preferences and obligations of all the shareholders.
While subscription of shares makes a shareholder the economic owner of the company, it is the provisions contained in the SHA that determines the extent to which the company and promoters are ceding the control and governance of the company to certain shareholders, typically the investors.
Purpose:
- To govern shareholder relations: It regulates the relationship between the shareholders and the management of the company.
- To protect minority shareholders: The SHA includes provisions that protect the interests of smaller investors against the potential actions of majority shareholders.
- To define company operations: It can detail rules for board appointments, decision-making, transfer of shares, and exit strategies.
Some examples of such rights and preferences are:
- Board representation: Specifies who has the right to appoint directors to the company’s board.
- Transfer of shares: Sets rules on how and to whom shares can be sold, such as granting other shareholders a right of first refusal/right of first offer (ROFR/ROFO).
- Veto rights: Gives certain shareholders the ability to block specific company decisions, such as a major acquisition or a change in the business plan.
- Exit strategies: Outlines provisions for the sale of the company, including “drag-along” rights (forcing minority shareholders to sell) and “tag-along” rights (allowing minority shareholders to join a sale).
- Dispute resolution: Establishes a pre-determined process for resolving disagreements among the parties.
- Deadlock resolution mechanisms – As per the requirements of the parties in an agreement
Apart from rights and preferences, SHA would also contain standard clauses around:
- Breach, Events of Default by parties and Termination
- Reps & Warranties, Indemnity, Confidentiality
- Non-Compete, Promoter Lock-in etc.
- Dispute Resolution, Arbitration, Governing Law etc.
- Shareholding pattern /cap tables, milestones and business plan in the Annexure
- ESOP Pool size and creation
SHA vs. Term sheet?
Many a times, SHA and Term sheet are interchangeably used as the document against which an investment is raised.
They are in this regard; you might have heard of cliched analogies such as
Term sheet is like an engagement, while SHA is the actual marriage of sorts between the startups and investors in some sense.
Here are a few more points that you can make note of:
- Term sheet is Intent: Term sheet is generally only a ‘firm intent to invest’ by the investor with the defined terms. It also is an abridged version of the eventual SHA/definitive agreement that parties would sign.
- SHA is Binding: However, SHA is a legally binding document and not abiding by it will constitute a breach.
- Can Investors renege on a signed term sheet? While investors can technically renege on a term sheet commitment, it is not an ideal situation. That said, there have been cases I have seen personally where a deal has not gone through post the execution of term sheet.
While signing a term sheet is often celebrated as a big milestone for a startup, it is not the end of the journey. A term sheet is only an expression of intent, and there are several technical, legal, and commercial reasons why a deal may not progress to the stage of signing definitive agreements. Some of the most common grounds include:
1. Expiry of Acceptance Period
- When an investor issues a term sheet, it typically comes with a limited validity period for acceptance.
- This acceptance window is usually two weeks or less; in the case of larger or more complex funding rounds, it could stretch up to four weeks.
- If the startup fails to provide formal acceptance within this time frame, the term sheet automatically lapses, giving investors the right to walk away without any further obligation.
2. Failure to Close the Round Within Stipulated Timelines
- Apart from the acceptance period, term sheets also set a maximum period to close the funding round.
- Closure usually means the execution of definitive agreements (such as SHA/SSA/SPA).
- The closing timeline is generally 8-12 weeks, but can vary based on deal size and complexity.
- If the round is not closed within the agreed period, the term sheet loses its validity, and investors are free to withdraw.
- That said, if the investor’s conviction to invest is strong, these timelines are often relaxed – in fact, there have been cases where deals were successfully closed more than a year after signing the term sheet.
3. Unfulfilled Conditions Precedent (CPs)
Most term sheets specify a list of conditions precedent that must be fulfilled before definitive documents are signed.
- These CPs often include:
- Transfer of intellectual property (IP) into the company,
- Hiring of critical senior management,
- Founders resigning from full-time employment elsewhere,
- Regulatory approvals or compliance clearances.
- If these conditions are not satisfied within the agreed period, investors may refuse to proceed further.
4. Red Flags in Due Diligence
- After signing the term sheet, investors conduct a comprehensive due diligence process. This covers:
- Legal due diligence – corporate records, contracts, statutory filings, IP ownership, employment agreements, litigation history.
- Financial due diligence – audited accounts, tax compliances, internal controls, liabilities.
- If material inconsistencies, gaps, or risks are discovered, investors usually insist that these be cured or rectifiedbefore signing definitive agreements.
- In cases where the issues are significant or systemic (e.g., unclear IP ownership, undisclosed liabilities, governance concerns), investors may decide to terminate the process altogether.
In summary, while a signed term sheet signals investor interest, it does not guarantee the completion of a funding round. The real commitment is established only once the definitive agreements are executed, and that is subject to timelines, conditions, and a satisfactory due diligence outcome.
