Shares Subscription Agreements: Purpose and Effect

Both start-ups and established companies often seek investment to fund growth and expansion, and one way to do this is by issuing new shares. Depending on the type of shares the company intends to offer investors, this may include either ordinary or preference shares. This practice is commonly known as raising capital through the issuance of shares or equity in the company, or by subscribing to shares.

Recently, a public company listed on Bursa Malaysia disclosed that it planned to raise capital in the company by issuing shares to new investors via a special purpose vehicle (SPV) that aimed to secure a minimum subscription of RM50 million. This method of raising funds is a typical approach utilized by publicly listed companies to attract additional investors and acquire more funding by offering shares to the public. The following article will provide a comprehensive explanation of subscription shares' characteristics and concept, with an emphasis on private limited companies.

Subscription Shares

Subscription shares refer to shares that investors can purchase by subscribing to them at a fixed purchase price in exchange for equity in the company. These shares can be ordinary or preference shares and may include an option for the company to buy them back at a predetermined conversion price and within a set period. Only the company itself can issue these shares, which are bought by a potential investor referred to as a subscriber. When investing in subscription shares, the funds paid by the investor are directly deposited into the company's account to facilitate the issuance of the new shares. This is distinct from share purchase agreements, where buyers and sellers transfer ownership of the shares, and the purchase price is paid to the vendor.

A private limited company can use a subscription of shares at any point in its development. The specifics of the subscription agreement will vary based on the type of shares being offered, such as ordinary, preference, or convertible redeemable preference shares. It's important to distinguish between a share sale and purchase agreement, which deals with the sale and transfer of shares from an existing shareholder and the existing share capital, and a share subscription agreement, which pertains to subscriptions that result in the issuance of new shares or classes of shares and an increase in the company's share capital to accommodate the new shares.

Shares Subscription Agreement

Once an investor agrees to invest in a company through a subscription of shares, a share subscription agreement (SSA) is executed between the investor, also known as the subscriber, and the company. The purpose of the SSA is to establish the company's commitment to issue a specific number of shares to the investor at a predetermined price. The SSA typically outlines the amount of the investment in exchange for the subscribed shares, along with other terms of the agreement, such as the subscription date when the investor is required to pay the subscription price for the shares. In the case of redeemable convertible preference shares, the agreement may also specify the date on which the investor can redeem or convert the shares.

It is important to differentiate between ordinary shares and preference shares as ordinary shares cannot be converted into preference shares while preference shares can be converted into ordinary shares. Since preference shareholders do not have voting rights, issuing preference shares does not dilute ownership as how ordinary shares would.

When an existing company issues new ordinary shares, it may lead to a reduction in the ownership of current shareholders. However, depending on the company's articles of association/constitution, existing shareholders may have the option to purchase a portion of the new shares being issued to prevent any dilution of their current shareholding in the company. This is often referred to as anti-dilution rights or the first right of refusal.

To ensure that the investors/subscribers in a company maintain their ownership percentage in the event of future share issuances, the SSA may contain provisions that give the investors the right to anti-dilution measures. These measures can include offering current shareholders the option to purchase a proportionate number of shares in any future share issuance, subject to the company's constitution or articles of association. The purpose of these measures is to protect investors from the risk of seeing new shares issued at a lower price than what they originally paid. For instance, an investor who initially bought shares at RM20 per share would be protected by this clause if the company were to issue new shares at RM15 per share. The SSA should include either a "weighted average" provision or a "ratchet-based" provision to cater for this situation. Under the former, the share price offered would be the difference between the original price and the new price, while under the latter, the shares would be sold at a lower price.

When companies are looking for investors, they often provide a term sheet that outlines the investment structure and the type of shares being offered. The term sheet also includes a summary of the provisions that are typically included in the share subscription agreement.

Difference between a Shares Subscription Agreement and Shareholders' Agreement

Frequently, both a share subscription agreement and a shareholders agreement are signed together, but they differ in their purpose. While a share subscription agreement pertains only to the purchase of shares by an investor from the company, a shareholders agreement includes information about ownership, the responsibilities and rights of shareholders, limitations on share transfers, and the company's management. Unlike a share subscription agreement, which involves only the investor/subscriber and the company, all shareholders must sign the shareholders agreement.

Key Clauses to be incorporated in a Shares Subscription Agreement

A share subscription agreement commonly includes certain standard provisions such as:

Conditions precedent: This clause outlines the requirements that must be met before the shares can be subscribed to. For instance, the company's directors or shareholders may need to pass specific resolutions before issuing new shares.

Confidentiality: This non-disclosure provision ensures that any information shared between the investor and the company remains confidential. As confidential data and trade secrets may be disclosed during the allotment of shares, it is crucial to include confidentiality clauses in the SSA.

Restraint against competition: This clause prohibits the investor from competing with the company for a specified period. This serves to protect the company's interests by preventing the investor from benefiting from and competing against the company for a certain number of years. However, certain restraint of trade and non-competition clauses may not be enforceable in Malaysia.

Tranches: This provision outlines the transaction's details, as typically laid out in the term sheet. This may include the subscription price, the number of shares to be issued, prescribed limits, and any vesting conditions.

Warranty and indemnity: This clause may declare that all information provided by the company is true and accurate and that either party will indemnify the other against any losses, liabilities, and damages that arise from any breach or damages. Such a provision encourages full and honest disclosure of important information and further protects the company and the investor from potential fraud.

In a nutshell

The act of subscribing to shares provides benefits to both the company and the investor/subscriber. The company can generate additional capital, while the investor/subscriber can acquire a percentage of ownership in the company or enjoy preferential dividend rights as a preferential shareholder.

However, it is critical to negotiate and draft the terms of the SSA accurately to reflect and document the intentions of both parties. It is considered best practice to ensure that agreements, including SSAs, are unambiguous and accurately reflect the parties' intentions. Inadequate specification of key elements such as conditions, rights of each party, and the nature of share transfers can lead to disputes in share subscription agreements.