Definitive Agreements
The binding agreements signed between an investee company and the investment manager representing the AIF to complete an investment — chiefly the share subscription agreement and the shareholders' agreement.
In plain language
Everything before this point is provisional. The teaser, the information memorandum and the management presentation are marketing. The term sheet is non-binding and "does not provide for any contractual rights whatsoever". Due diligence produces reports, not obligations.
The definitive agreements are where the deal becomes law between the parties. The workbook defines the term as "the set of binding agreements signed between the investee company and the investment manager representing the AIF to complete the investment transaction".
They are built on the final term sheet. After due diligence, the term sheet may be renegotiated, and "the final term sheet as executed once again between the parties becomes the basis for legal documentation". Legal counsel, who advised on contractual rights in the term sheet, carries that advice into the definitive agreements.
How it works
The main contracts (section 7.3):
| Agreement | Between | Purpose |
|---|---|---|
| Share Subscription Agreement (SSA) | The AIF and the investee company | The main transaction document where a new issue of shares is required. Sets out the terms of the financing and provides rights superior to an ordinary investor under the Companies Act as required. Also covers reconstitution of the board with the AIF's nominees, vacation of office by existing directors, other key appointments and the procedures to implement them. |
| Disclosure Letter | Issued by the investee company to the AIF, qualifying the SSA | A formal qualifier to the absolute representations and warranties in the SSA. By listing specific exceptions — existing litigation, pending tax disputes — it shifts the burden of disclosed liabilities from the promoters to the AIF. Once a fact is disclosed, the AIF is deemed to have notice and generally cannot later claim breach of warranty or indemnity for it. |
| Shareholders' Agreement (SHA) | All existing shareholders and the AIF; the company joins if clauses need privity of contract with it | Binds all existing shareholders to the agreed rights and obligations — needed because the SSA binds only the company, not its shareholders. |
Housekeeping the workbook insists on.
- Where the promoter owns all the shares or controls the other shareholders, a combined SSA incorporating SHA provisions may be used.
- If there is an existing SHA, avoid multiple SHAs with conflicting provisions: amend them all onto a common footing. Usually the latest agreement with all shareholder signatures supersedes previous ones.
- The articles of association are amended to incorporate the new SHA so that it is enforceable.
- Associated documentation may include management contracts with the key management team, additional financing agreements, and undertakings or declarations from founders and principal shareholders.
What they carry. The investor protection rights — milestone valuation, dividend rights, anti-dilution rights, affirmative and veto rights, liquidation preference and exit rights. Even exit pricing is fixed here: a put option price "is usually specified as a formula in the definitive agreements so as to avoid ambiguity at the time of the transaction".
A worked example
Illustrative figures. After due diligence, Deccan Consumer Fund II and Nagpur Agro Foods execute a final term sheet at a pre-money valuation of Rs 580 crore for a Rs 120 crore investment — a post-money stake of 120 / 700 = 17.1%. Lawyers turn it into definitive agreements:
| Document | Key contents in this deal |
|---|---|
| Share Subscription Agreement | Issue of equity and CCPS for Rs 120 crore; one board seat for the fund's nominee; conditions precedent including assignment of the brand trademark to the company |
| Disclosure Letter | Discloses the Rs 4.2 crore indirect tax demand and two pending labour cases |
| Shareholders' Agreement | Signed by the two promoters, their family holding company, an existing angel investor, the fund and the company; affirmative rights, tag-along, drag-along, a put option on promoters priced to deliver a 14% IRR if no IPO within 6 years |
| Amended articles | Incorporate the SHA so its rights are enforceable |
Because the tax demand is in the Disclosure Letter, the fund cannot later claim a breach of warranty over it — which is why it negotiated a specific indemnity for it in the SSA. The angel investor already had an older SHA; it is amended so there are not two shareholders' agreements with conflicting clauses.
Why NISM asks about it
Chapter 7 (Investment Process and Governance of Funds) defines definitive agreements at 7.3, immediately after due diligence review, and follows with the investor protection rights they contain at 7.4; Chapter 10 (Fund Monitoring, Reporting and Exit) notes that put option pricing is fixed in them. The chapter's sample questions ask which document is a definitive agreement. Expect questions on the parties to the SSA and the SHA, why an SHA is needed at all, and the effect of a disclosure letter.
Common exam traps
- The term sheet is not a definitive agreement — it is non-binding. Definitive agreements are binding.
- The SSA is between the AIF and the company; the SHA is among all existing shareholders and the AIF. The company joins the SHA only where privity of contract with it is needed.
- The SSA binds only the company, which is exactly why an SHA is needed.
- Do not confuse a share subscription agreement with the contribution (subscription) agreement between an investor and the AIF in Chapter 9. Only the first is a definitive agreement for an investment.
- A PPM, a trust deed and articles of association are not definitive agreements, though the articles are amended to make the SHA enforceable.
- A disclosed fact cannot later found a warranty claim. The disclosure letter shifts that risk to the AIF.
Where this is taught
Free preparation for NISM Series XIX-ARelated terms
- Affirmative RightsInvestor protection rights under which specified corporate actions of an investee company need the AIF's express consent, whatever the size of its shareholding — described as "positive control".
- Put optionA contract giving its buyer the right, but never the obligation, to sell the underlying at a fixed strike price — insurance against a fall, bought for a premium.
- Disclosure LetterA document the investee company issues to the AIF alongside the Share Subscription Agreement, listing exceptions to its warranties so disclosed risks shift from the promoters to the AIF.
- Liquidation PreferenceA right that, if the investee company is liquidated, the AIF's preferred securities are paid a set amount — its investment or a multiple of it — before other shareholders receive anything.
- Share Subscription AgreementThe main definitive agreement between an AIF and an investee company for a fresh issue of shares — setting the terms of the investment and the AIF's rights beyond an ordinary shareholder's.
- Shareholders' AgreementAn inter se agreement between an AIF and all existing shareholders of the investee company, binding them to the rights and obligations of the deal — made enforceable by amending the articles.
- Veto RightsAn investor's right to block a corporate action of the investee company even when it has the requisite majority — "negative control", as opposed to the "positive control" of affirmative rights.
- Term SheetThe non-binding document in which an AIF and an investee company set out the main terms of a proposed investment. Once signed, it leads to due diligence and then to the binding definitive agreements.
- Deal SourcingThe investment manager's work of finding, screening and completing investments in suitable unlisted companies — through networks, intermediaries and its own research — to build a deal pipeline.
- Preliminary Investment MemorandumA memorandum a fund's investment team may present to its Investment Committee, detailing a proposed investment and deal structure, to get authorisation to sign the term sheet.
- Virtual Data RoomThe secure repository in which an investee company places detailed confidential records — constitutional documents, accounts, tax returns, contracts, IP and employee records — for the investor's due diligence.
- Financial DDRThe part of an AIF's due diligence review that verifies an investee company's books, financial statements, representations and tax position — usually for at least three past financial years.
- Pre-emptive RightAn anti-dilution right letting a shareholder keep its percentage holding by taking up its pro-rata share of any new shares the company issues in later financing rounds — a right, not an obligation.