Understanding Reserved Matters in Shareholders’ Agreements

In the dynamic world of business collaborations, securing mutual trust between founders and investors is the foundation for successful partnerships. Reserved Matters, often referred to as affirmative rights, reserved rights, or exclusive rights, are pivotal in safeguarding critical decision-making processes. These provisions ensure that major business decisions are not made unilaterally but rather require the explicit approval of key stakeholders.

Reserved Matters are a key component of investment agreements like the Shareholders’ Agreement (SHA) or the Investors’ Agreement, playing a crucial role in fostering balanced corporate governance. This blog delves into the significance, structure, and implications of Reserved Matters to help entrepreneurs and investors establish transparent, legally enforceable agreements.

What Are Reserved Matters?

Reserved Matters are specific business decisions requiring approval from founders, the board of directors, or investors before they can be executed. These provisions are typically outlined in the Term Sheet and later incorporated into Definitive Agreements such as the Shareholders’ Agreement (SHA) or Investors’ Agreement. These decisions go beyond ordinary approvals as defined under the Companies Act, 2013 and its associated rules.

Common Examples of Reserved Matters

Some of the most frequently included Reserved Matters are:

• Issuance of new shares, ESOP pools, or any changes in capital structure.
• Amendments to the Memorandum & Articles of Association (MoA & AoA).
• Alteration of rights attached to shares, buybacks, or capital reduction.
• Mergers, acquisitions, or asset sales.
• Significant accounting policy changes or changes in auditors.
• Appointment or removal of Key Managerial Personnel (CEO, CFO, etc.).
• Taking on significant debt or external financing.
• Dividend declarations and profit distributions.
• Formation of subsidiaries, joint ventures, or related-party transactions.
• Initiation of a new business line or expansion into different sectors.

Why Are Reserved Matters Important?

Including Reserved Matters in a Shareholders’ Agreement serves multiple purposes:

• Investor Protection – Prevents major business changes without investor consent.
• Founder Control – Allows founders to retain influence over crucial decisions.
• Operational Stability – Ensures critical decisions align with business strategy.
• Risk Mitigation – Reduces potential conflicts by clearly defining mutual approvals.

How Reserved Matters Should Be Structured in Term Sheets & Definitive Agreements

A well-drafted Term Sheet should clearly define Reserved Matters, including:

• Approval thresholds (e.g., affirmative vote from investors or unanimous approval).
• Voting rights structure (e.g., special resolution vs. ordinary resolution).
• Specific parties required to approve key decisions.

Once agreed upon, these provisions should be formally documented in the Definitive Agreements, ensuring legal enforceability and preventing ambiguity.

Impact of Reserved Matters on Corporate Governance

Under the Companies Act, 2013, most decisions are made through ordinary or special resolutions. However, when an investor, minority JV partner, or shareholder holds affirmative rights or veto rights, they can block specific decisions even with less than 25% equity in the company. This means:

• Majority shareholders cannot act unilaterally on key issues.
• Investors and minority stakeholders retain decision-making power on crucial matters.
• Businesses must ensure a balanced governance structure to prevent deadlocks.

What Happens if Reserved Matters Are Breached?

If a party violates Reserved Matters agreements, potential consequences include:

• Breach of Contract – Legal action against the violating party.
• Reversal of Unauthorized Actions – Decisions taken without approval may be voided.
• Financial Penalties – Some agreements impose monetary penalties for non-compliance.
• Investor Exit Rights – Investors may have a right to exit under favorable terms. Voting or Board
• Restructuring – Violating parties may lose decision-making power.

Ensuring Clarity in Decision-Making Authority

A well-structured Shareholders’ Agreement (SHA) should clearly outline:

• Founder-approval matters
• Investor-consent matters
• Board-controlled decisions
• External regulatory requirements

This clarity helps prevent governance disputes and ensures smooth decision-making.

Reserved Matters & Free Transferability of Shares

Another critical aspect of Shareholders’ Agreements is share transferability, where investors seek flexibility in exiting. Key considerations include:

• Right of First Refusal (ROFR) – Ensuring existing investors get the first opportunity to buy shares.
• Tag-Along & Drag-Along Rights – Providing exit rights in case of share sales.
• Lock-in Periods – Restricting early exits to maintain stability.
• Approval Mechanisms – Controlling who can become a shareholder.

Sunset Clauses: Limiting Reserved Rights Over Time

Sunset clauses allow certain investor rights or restrictions to expire after a predefined period, ensuring:

• Founders regain operational autonomy after a certain time.
• Veto powers or reserved matters are phased out gradually.
• Avoidance of perpetual investor restrictions that hinder business growth.

Notable Case Studies on Reserved Matters in Investment Deals

• Flipkart & SoftBank – SoftBank initially had reserved rights over financial decisions, which diminished after Walmart’s acquisition.
• OYO & Sequoia Capital – Sequoia’s veto rights impacted OYO’s international expansion.
• Uber & Benchmark Capital – Reserved matters played a role in Travis Kalanick’s exit from Uber.

Summary

Reserved Matters, also known as affirmative rights, exclusive rights, or reserved rights, are a fundamental aspect of Share Subscription and Shareholders’ Agreements (SSHA). They play a crucial role in ensuring a fair balance between investor rights and founder autonomy during fundraising.

A well-structured agreement should protect investors while allowing founders to operate efficiently. Important provisions such as free transferability of shares, sunset clauses, and dispute resolution mechanisms contribute to long-term stability and governance.

Legal Compliance Alert: Before issuing equity shares with differential voting rights (DVRs), companies must strictly adhere to Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014. Compliance with these regulations ensures alignment with corporate governance standards.

While veto rights and affirmative voting rights help safeguard investor interests, they must be structured carefully to avoid conflicts with corporate democracy and the Companies Act, 2013. A balanced governance framework is essential to foster business growth while protecting stakeholder rights.

How Can LegalWiz Help?

Structuring Reserved Matters demands precision, expertise, and compliance with legal frameworks. LegalWiz.in offers end-to-end support in:

• Drafting customized Shareholders’ Agreements tailored to your business needs.  
• Ensuring compliance with corporate governance laws.  
• Assisting with company restructuring or subsidiary registration for unrelated business activities.

Our team of experts ensures your investment agreements safeguard your interests while promoting operational efficiency.

Get in touch with LegalWiz.in to transform governance challenges into growth opportunities