Shareholders agreement for a startup in India: key clauses

The term sheet gets the attention; the shareholders' agreement does the governing. Once the round closes, it decides who sits on the board, what founders can do without asking, and how anyone ever sells. Founders who skim it in the last week of a raise live with it for years.

This guide explains the clauses founders meet most often in an Indian startup SHA and the law behind them. It's educational, not legal advice; have your own lawyer, not the investor's, review the draft.

What is a shareholders' agreement in an Indian startup?

A shareholders' agreement (SHA) is a contract among the company, its founders and its investors that sets governance and transfer rules after an investment. It sits beside the share subscription agreement, which covers the investment itself, and its key terms are copied into the Articles of Association so they bind the company.

Company law gives the SHA a frame. A private company must, by its Articles, restrict the right to transfer its shares, under section 2(68) of the Companies Act, 2013. The SHA says how: who is offered shares first, who can force or join a sale, and which decisions need consent.

Which SHA clauses matter most to founders?

Read seven groups closely: reserved matters, board composition, information rights, transfer restrictions, anti-dilution, exit rights and founder lock-in. Together they decide how much control you keep after the round, and most can't be changed later without the investor's consent.

Clause	What it does	Question to ask
Reserved matters	Lists decisions that need investor consent	Are routine operating decisions on the list?
Board composition	Sets who appoints directors and observers	Do founders keep a majority, and until when?
Information rights	Sets the reports the company must send	Can we deliver these from reports we already make?
ROFR or ROFO	Gives existing holders first chance at shares on sale	How long is the offer window?
Tag-along	Lets investors join a founder's sale on the same terms	Does it catch small transfers too?
Drag-along	Lets a set majority force everyone to sell	What price floor and start date protect founders?
Anti-dilution	Adjusts the investor's price if a later round is cheaper	Weighted average or full ratchet?
Exit rights	Sets IPO, sale or buyback deadlines	What happens if the deadline passes?
Founder lock-in	Stops founders selling before a date or event	What are the exceptions?

How do reserved matters and board seats work?

Reserved matters are decisions the company can't take without the investor's written consent or its nominee director's vote, such as new share issues, changes to the Articles, large debt or a sale. Board composition sets how many directors each side appoints. Keep the reserved list to decisions that change the investor's position.

A private company needs at least two directors under section 149, and section 161(3) lets the board appoint a director nominated under an agreement, subject to the Articles. That's how an investor's nominee joins. Observers have no footing in the Act; the seat exists only in the SHA. Board seats and information rights covers what investors usually ask for.

Watch how consent is drafted. If every reserved matter needs approval from every investor, one small holder can block a decision. Ask for consent from a stated majority of investors instead.

How do transfer restrictions like ROFR, tag and drag work?

Transfer restrictions control who can become a shareholder. A right of first refusal gives existing holders the first chance to buy shares being sold; tag-along lets investors sell alongside a founder on the same terms; drag-along lets a set majority force everyone to sell to a buyer. Each needs a clear process and timeline.

For founders, drag-along deserves the closest read. Ask for a minimum price before a drag can run, a date before which it can't, and the same terms for everyone dragged. Term sheet clauses Indian angels should read shows how anti-dilution and pro-rata rights carry into the SHA.

Founder lock-in usually sits beside founder vesting in India. Vesting decides how many shares you keep if you leave; the lock-in decides when you may sell the shares you keep. Check that the two clauses use the same definitions.

Is a non-compete clause in an SHA enforceable in India?

Only partly. Section 27 of the Indian Contract Act makes any agreement restraining someone from a lawful profession, trade or business void to that extent, with an exception for a seller of goodwill. Courts have generally refused restraints that run after the relationship ends, while restraints during it are treated differently.

The text is short. Section 27 of the Indian Contract Act, 1872 has one exception: a person who sells a business's goodwill may agree not to carry on a similar business within local limits a court finds reasonable.

In Percept D'Mark v Zaheer Khan, decided in 2006, the Supreme Court said "a restrictive covenant extending beyond the term of the contract is void". So a non-compete while you're a director, employee or shareholder stands on firmer ground than one running years after you leave. How a court treats a founder who also sold shares depends on the facts; ask a lawyer.

Why must the Articles of Association mirror the SHA?

Because the Articles bind the company and its shareholders, and the SHA on its own may not. The Supreme Court held in 1991 that a share transfer restriction not in the Articles binds neither the company nor the shareholders. So investors amend the Articles at closing to carry the SHA's key rights.

The case is V.B. Rangaraj v V.B. Gopalakrishnan. The court held that the only restriction on transferring a company's shares is the one its Articles lay down, so a transfer clause left only in the SHA risks failing against the company and a buyer.

The Articles change by special resolution under section 14, which needs votes in favour of at least three times the votes against under section 114. Section 5(3) also allows entrenchment, so chosen articles can be altered only by a stricter process; in a private company, adding entrenchment later needs every member to agree, under section 5(4).

If a right matters, it belongs in the Articles. An SHA clause the Articles don't carry is a promise, not a rule.

When the SHA and the Articles say different things, expect a dispute. Ask your lawyer for a table mapping each SHA clause to its article, and keep it with the cap table.

Questions

What is the difference between an SHA and the Articles of Association?

The SHA is a private contract among the company, founders and investors. The Articles are the company's constitution, filed with the Registrar and binding on the company and every shareholder. Investor rights in the SHA are usually copied into the Articles so the company itself is bound by them.

Is a shareholders' agreement mandatory for a startup in India?

No law requires one. A private company can run on its Articles alone. Investors usually ask for an SHA in a priced round because they want consent rights, board seats and transfer rules in writing, and co-founders often sign one earlier to cover vesting and exits.

Can an SHA stop a founder from starting a competing company after leaving?

Rarely. Section 27 of the Indian Contract Act voids agreements restraining a lawful trade, except on a sale of goodwill, and the Supreme Court held in 2006 that a restrictive covenant extending beyond the term of the contract is void. Restraints during the relationship stand on firmer ground. Ask a lawyer.

What are reserved matters in a shareholders' agreement?

Reserved matters are decisions the company can't take without investor consent, such as issuing new shares, changing the Articles, taking on large debt, changing the business or selling the company. Founders should keep the list to decisions that change the investor's position, not routine operations.

Sources: Companies Act, 2013, sections 2(68), 5, 14, 114, 149 and 161, India Code · Indian Contract Act, 1872, section 27, India Code · Supreme Court of India, V.B. Rangaraj v V.B. Gopalakrishnan, 28 November 1991, via Indian Kanoon · Supreme Court of India, Percept D'Mark (India) Pvt Ltd v Zaheer Khan, 22 March 2006, via Indian Kanoon

For more on how startup funding works in India, read the MyStartupValley blog or visit mystartupvalley.com.