During the foundation of any startup, promoters play a pivotal role, not just in moulding the idea, but also in steering the business through its early stages. As a startup begins to grow and attract outside funding, clarity around each promoter's role, responsibilities, and rights becomes increasingly essential. A promoter's agreement serves this purpose, establishes a clear understanding among the founding team, and serves as a safeguard against future conflicts.
Unlike employment contracts, a promoter's contract does not address salaries or benefits. Instead, it serves as a foundational legal document that governs decision-making power, equity structure, intellectual property ownership, and resolution pathways for future conflicts. It is a risk mitigation and governance tool that aligns with Indian corporate laws and investment standards.
Raising investment marks a significant milestone in the journey of any startup. However, when a startup begins to explore external investment, whether through a seed round, pre-Series A funding, or angel funding, the emphasis naturally shifts beyond just the business idea or market opportunity. At this stage, investors pay close attention to how the startup is legally structured and whether its internal governance is well-defined. They seek clarity on control, ownership arrangements, and mechanisms to handle disputes. To address these concerns and align the interests of all promoters, having a well-drafted promoter's agreement becomes essential.
Understanding Who a Promoter Is (Legally)
Under Section 2(69) of the Companies Act, 2013, a promoter is defined as any person who is named as such in the prospectus, is listed in the annual return, or exercises direct or indirect control over the affairs of the start-up. This statutory recognition is not merely descriptive and imposes specific legal duties, including fiduciary responsibilities and mandatory disclosure obligations, which promoters must adhere to under applicable corporate laws and regulatory frameworks.
Essential Clauses in a Promoters' Agreement
The Promoters' Agreement sets out the following key provisions:
1. Equity Shareholding and Capital Commitment
It is essential to clearly specify each promoter's shareholding percentage and financial contribution. Incorporating vesting schedules, for example, a four-year vesting schedule with a one-year cliff, helps ensure that equity ownership aligns with ongoing involvement and a long-term commitment to the startup.
2. Defined Duties and Decision-Making Rights
Each promoter's role, whether as CEO, CTO, or CFO, should be clearly defined in the agreement. It is essential to distinguish these strategic and governance-related roles from employment-related rights and benefits. This separation helps avoid potential misclassification and ensures that promoters are not inadvertently treated as employees under applicable labour laws, including the Industrial Disputes Act, 1947.
3. Voting Thresholds and Reserved Matters
A well-drafted promoter's agreement defines which business decisions require unanimous consent of the promoters, and which can be decided by a simple majority. This ensures alignment with the board's decision-making provisions under Section 179 of the Companies Act, 2013.
4. Restrictions on Transfer of Shares
The agreement should clearly outline provisions such as lock-in periods, right of first refusal, drag-along rights, and tag-along rights. These clauses are essential to prevent promoters from exiting the business prematurely or transferring their shares to third parties who may not align with the interests of the startup or its stakeholders.
5. Dispute Resolution Mechanism
Including a mandatory arbitration clause in the promoter's agreement, in accordance with the Arbitration and Conciliation Act, 1996, ensures that any disputes are resolved in a timely and confidential manner. Specifying a recognised institutional arbitration forum further strengthens the dispute resolution mechanism and provides additional assurance to investors.
6. IP Ownership and Confidentiality
All intellectual property developed by the promoters, whether before or during the startup's formation, must be formally assigned to the startup. This ensures that the company holds clear and undisputed ownership over its core assets, thereby safeguarding it from potential claims or disputes under the Patents Act, 1970, or the Trademarks Act, 1999.
7. Non-Compete and Non-Solicitation Restrictions
Reasonable, time-bound restrictions that comply with the Indian courts' stance on the enforceability of non-compete clauses should be included. Typically, non-compete periods of six to twelve months post-exit are considered reasonable.
8. Execution Timing: Getting It Done Early
Promoters' agreements should ideally be executed before the startup's incorporation or immediately thereafter. Postponing the execution of such contracts until investors come on board may dilute the promoters' bargaining power and lead to ambiguities in governance and decision-making responsibilities.
9. Investor Due Diligence and Regulatory Scrutiny
Investors today expect startups to comply with SEBI (LODR) Regulations on related-party transactions and promoter disclosure norms. The promoter's agreement plays a direct role in satisfying these requirements by providing clarity on voting rights, equity ownership, and decision-making protocols.
Well-drafted promoters' agreements help avoid complications during future funding rounds, such as Series A or Series B, when external investors closely examine the cap table and governance documentation. Ensuring clarity and consistency at the early stage strengthens the startup's position during due diligence.
Pitfalls That Startups Must Avoid:
- Delaying the Agreement: Waiting until investors push for it means losing leverage on key clauses, such as dilution protection and exit rights.
- Copy-Pasting Templates: Using generic agreements that do not consider the Indian regulatory context (like SEBI rules, Companies Act, FEMA guidelines) can result in unenforceable or illegal provisions.
- Ignoring Dilution and Vesting Protections: Startups without these safeguards risk promoters retaining disproportionate rights even after ceasing to be actively involved.
Tax Considerations for Promoter Compensation
When drafting a promoter's agreement, it is imperative to incorporate provisions that address the tax implications of promoter compensation mechanisms. Structures such as ESOPs, Phantom Stock Options, sweat equity shares, partly paid shares, and convertible warrants must be carefully evaluated for their tax implications under the Income Tax Act, 1961.
For instance, ESOPs are taxed as perquisites at the time of exercise, whereas Phantom Stock Options result in salary income taxation upon cash settlement. Sweat equity shares are taxed based on their fair market valuation at the time of allotment, while partly paid shares and warrants may trigger capital gains tax upon final payment or conversion, depending on their contractual terms.
A comprehensive promoters' agreement should clearly delineate these modes of compensation and allocate associated tax liabilities. This not only ensures statutory compliance but also enables promoters and the startup to achieve optimal tax efficiency and clarity, thereby reducing future disputes and litigation risks.
Regulatory Approvals for Share Issuances to Promoters
When startups plan to issue equity, convertible instruments, or compensation-based securities to promoters, several regulatory approvals may be necessary. For unlisted companies, share issuances must comply with the Companies (Prospectus and Allotment of Securities) Rules, 2014, particularly when private placements or preferential allotments are involved. The board must pass a resolution, which is typically followed by shareholder approval in many cases. If foreign investors or promoters are concerned, the Foreign Exchange Management Act (FEMA) regulations regarding Foreign Direct Investment (FDI) will apply. Startups must also adhere to valuation guidelines prescribed by the Income Tax Act, 1961, and FEMA to prevent future scrutiny from regulatory authorities (Source).
Data Room Readiness and Legal Due Diligence
Startups eyeing external funding must anticipate investor-led legal due diligence. A signed promoters' agreement is often among the first documents requested for review. Legal teams conducting diligence will check for consistency between the promoters' agreement, shareholders' agreement, and the startup's Articles of Association. They will also examine past equity issuances, board resolutions, and statutory filings for compliance gaps. Any inconsistencies between the promoters' agreement and statutory records filed with the Registrar of Companies under the MCA-21 portal could result in red flags during fundraising rounds. Therefore, startups are encouraged to maintain a comprehensive data room with updated agreements, board minutes, and compliance certificates.
Illustratively, in 2021, a HealthTech startup faced significant litigation when a dormant founder-promoter refused to divest his 30% stake during a crucial Series A funding round. The absence of vesting and drag-along clauses in the shareholder agreement led to a nine-month delay in securing funds.
In contrast, Edu Spark Innovations, a Mumbai-based edtech
startup, successfully navigated a similar situation in 2022. The
company relied on a carefully structured promoters' agreement
with clear exit, vesting, and voting provisions to execute a swift
capital restructuring ahead of its Series B funding round, which
helped secure investor confidence and ensured timely closure.
Such well-drafted clauses play a crucial role in providing clarity,
minimizing disputes, and facilitating smooth decision-making during
critical business events.
Applicability of Laws and Acts Referenced (2023–2025)
All laws and regulations cited in this article remain in force as of 2025. The Companies Act, 2013, including Sections 2(69) and 179, continues to govern corporate governance and the definition of promoters. The Arbitration and Conciliation Act, 1996, remains in effect with minor procedural amendments, serving as the primary framework for resolving contractual disputes. The Industrial Disputes Act, 1947, although superseded by the Industrial Relations Code, 2020, remains partially applicable in states where the new Labour Codes have not yet been implemented. The Patents Act, 1970, and the Trademarks Act, 1999, are fully operative and regulate IP assignment and protection. The Income Tax Act, 1961, continues to apply to ESOPs, sweat equity, and capital gains, while the Foreign Exchange Management Act (FEMA), 1999, governs foreign investment and FDI. The SEBI (LODR) Regulations, 2015, remain in force and apply to listed entities. The Companies (Prospectus and Allotment of Securities) Rules, 2014, regulate private placements and share issuances to promoters.
Legal Readiness is Business Readiness
More than a legal safeguard, a promoter's agreement can also catalyse business growth. By clarifying ownership and control, reducing the risk of litigation, ensuring regulatory compliance, building investor confidence, and protecting intellectual property, it lays the foundation for long-term stability. Startups that institutionalize governance early through such mechanisms are far better positioned to scale, secure funding, and avoid internal conflicts that could otherwise jeopardize their growth.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
