Private Rights, Public Markets: Why An IPO Changes The Bargain Between A Company And Its Investors

The real question is not simply what happens to the shareholders’ agreement on the day of listing, but how an IPO-bound company should handle the rights negotiated with founders and investors throughout its journey.

By the time a company reaches the listing stage, its Capital Structure may reflect several rounds of investment, with investors having invested at different stages of the company’s growth and on different investment terms. Those investments may have come with sets of special rights negotiated by the company with its founders and investors, spanning board nomination rights, affirmative-vote rights over reserved matters, information and inspection rights, anti-dilution protections and contractual exit mechanisms. Such rights are recorded in agreements, usually in shareholders’ agreement (SHA) & the articles of association.

The accumulation of these rights reflects an underlying commercial bargain. During its growth, a company may seek to expand its operations, pursue new business opportunities or advance to its next phase of development. While the company and its promoters seek capital to support these objectives, a private equity (PE), venture capital (VC) or other investor commits capital with the expectation of earning a return and eventually realizing that return through an exit. The interests of both parties are therefore commercially aligned, although their objectives are different. The promoters generally continue to manage the business, while the investor’s return depends on the company’s performance and the value ultimately realized from its investment. Unlike shares of a listed company, shares of a privately held company cannot be sold through stock-exchange trading. The investor must therefore rely on finding a buyer or securing another suitable exit opportunity, remaining exposed to the company’s business, valuation and liquidity risks in the meantime.

It is against this backdrop that the private bargain takes shape. As part of the investment terms, the investor negotiates rights to monitor the company’s performance, protect its economic interests and secure contractual avenues for liquidity. However, the effect of these rights extends beyond investor’s own protection. Affirmative-vote rights may create hurdles for corporate decisions, board nomination and information rights may influence oversight and access to management information, while transfer and exit rights may affect future transactions. Collectively, these arrangements create a privately negotiated layer of governance alongside the company’s statutory framework, allocating influence, information and protections differently among shareholders. SEBI’s 2023 consultation paper (Consultation Paper) recognized such rights as common features of pre-IPO investment arrangements¹.

The transition to a listed company, however, changes the environment in which this private bargain operates. With the introduction of public shareholders, rights negotiated with select investors must be reconsidered against the requirements of corporate governance, public disclosure and regulated securities trading. If rights cease prematurely and the IPO does not proceed, investors may lose their negotiated protection while the company remains unlisted. Conversely, their continuation without appropriate review may constrain corporate decision-making and create an asymmetry in rights among shareholders post-listing, particularly in relation to control, influence over corporate decisions and access to information. The challenge is therefore to reassess each right, its implications for the company and other shareholders, and its appropriate treatment, whether through waiver, suspension, modification, termination or lawful continuation, at the relevant stage of the IPO.

Different Rights, Different Consequences

The first step is to identify what each right is intended to protect. These rights serve different commercial purposes and may have different implications for the IPO and the company after listing.

The effect of each right depends on how it is structured and drafted, its scope, the parties bound by it and the circumstances in which it may be exercised.

What listing changes

An IPO marks a significant transition in a company’s ownership and governance structure. Through a fresh issue, the company may raise capital from public investors, while an offer for sale (OFS) provides existing shareholders, including PE/VC investors, an opportunity to realize part or all of their investment. Listing also creates a regulated secondary market through which shareholders may subsequently seek an exit (subject to applicable post-listing lock-in requirements). With the introduction of public shareholders, the company becomes accountable to a broader shareholder base, bringing greater emphasis on transparency, equitable treatment and corporate governance.

This transition changes the commercial context in which special rights were originally negotiated. Rights negotiated when an investor committed substantial capital, assumed significant risks or faced limited liquidity may not retain the same commercial rationale after listing. For instance, an investor may continue to enjoy board nomination or affirmative-vote rights despite a substantial reduction in its shareholding through dilution or partial exit. This creates a potential asymmetry between its economic interest and continuing influence over the company, particularly when incoming public shareholders do not enjoy comparable rights.

SEBI recognized this concern in its Consultation Paper, observing that certain nomination rights could continue despite significant dilution and effectively operate in perpetuity. Regulation 31B of the SEBI LODR Regulations subsequently introduced a requirement for special rights granted to shareholders of listed entities to be approved through a special resolution once every five years, subject to specified exceptions. The regulation recognizes the possibility of special rights in listed companies but does not dispense with the need to examine their commercial justification or compliance with other applicable laws. In particular, rights concerning board representation, corporate decision-making or access to information must be assessed independently under the applicable company and securities-law framework.

Moreover, special rights may also complicate promoter identification at the IPO stage. Board nomination, affirmative-vote and other consent rights may, depending on their scope and combined effect, raise questions as to whether an investor enjoying such special rights exercises control over the issuer under the ICDR and SAST Regulations. Neither a minority shareholding nor the contractual description of these rights as protective is conclusive; their actual influence over the issuer’s management or policy decisions must be examined.

The timing of this assessment is equally important. Rights proposed to be waived, modified or terminated at a later IPO milestone (RHP or listing stage) may still be operative when the DRHP is filed. The issuer and its advisers must therefore assess the control position based on the rights then in force, consider the effect of subsequent changes and ensure that promoter identification and offer-document disclosures accurately reflect the position at the relevant stages of the IPO.

Reconsidering the private bargain at IPO

IPO preparation may involve several corporate and transactional steps, including changes to the capital structure, conversion of securities, pre-IPO placements, amendments to the articles of association. These actions may trigger contractual rights requiring investor consent, waiver or adjustment. The issuer and its advisers must therefore identify the rights affected by the proposed transactions and determine the action required at each stage of the offering.

There is no uniform treatment applicable to every special right. The appropriate approach depends on the nature and purpose of the right, its drafting, the obligations it creates, the proposed IPO structure and applicable regulatory requirements. For instance, pre-emption and anti-dilution rights may require waivers or adjustments for a fresh issue, while ROFR, ROFO and tag-along rights may require specific waivers for an OFS. Board nomination, affirmative-vote and information rights require consideration of their governance and regulatory implications, while exit rights must be examined against the agreed exit conditions. Depending on these factors, a right may be exercised, waived for a particular transaction, suspended, modified or brought to an end at an appropriate stage.

However, the treatment of special rights is not solely a matter of contractual discretion. SEBI's IPO review practice has also sought the cessation of existing pre-IPO special shareholder rights upon listing. This reflects, among other considerations, the pari passu ranking of equity shares offered to the public under the ICDR Regulations and the principles of equitable treatment of shareholders and effective shareholder participation in key corporate governance decisions under Regulation 4(2)(c) of the LODR Regulations. While these principles do not require every shareholder to have identical contractual entitlements, they call for scrutiny of privileges that may affect the rights and interests of public shareholders. The parties must therefore distinguish between rights requiring action during IPO preparation, existing special rights to be addressed at listing and any proposed post-listing rights that may be established in compliance with Regulation 31B and other applicable laws.

What if the IPO does not proceed?

The exit arrangement should ideally be negotiated when the investment agreement is originally executed, rather than when the company subsequently approaches an IPO. The parties should agree on the proposed exit route, expected timeline, what constitutes a qualifying exit and the obligations of the company and promoters to facilitate it While an IPO may be the preferred route, the agreement should also contemplate other alternatives, such as a strategic sale, a secondary sale to another financial investor or third party, a purchase by the promoters or a company buyback, where legally permissible. The circumstances in which these alternatives become available, their sequence and the applicable timelines should be clearly agreed at the outset. A common contractual oversight is to contemplate an IPO as an exit route without adequately addressing the possibility of its withdrawal or failure, particularly the consequences for investor rights that may have been waived, suspended or modified in anticipation of the offering.

When a company proposes an IPO, the parties must examine the existing investment arrangements and determine how the proposed offering affects the investor’s rights and exit obligations. Where the agreement already contemplates an IPO and the possibility of its failure, the parties should assess whether the proposed offering satisfies the agreed conditions and whether any further consents, waivers or amendments are required. Where these matters were not addressed at the investment stage, the parties should negotiate and document the treatment of the investor’s rights and obligations during the IPO process, upon listing and if the IPO does not proceed.

In either case, an obligation to complete a qualifying IPO, a right to participate in an OFS and a commitment to facilitate an actual sale of the investor’s shares are distinct arrangements, with different contractual consequences. The parties must therefore assess the proposed IPO against the agreed exit conditions and clearly specify when any changes to existing rights take effect, which rights are intended to cease upon listing and the consequences if the IPO is withdrawn, abandoned or not completed within the agreed period. In particular, the treatment of existing investor protections, unfulfilled exit obligations and alternative exit rights should be expressly addressed, subject to applicable law.

The parties should accordingly document two distinct outcomes: the rights and obligations applicable upon successful listing, including any outstanding exit obligations, and those that will continue or be reinstated if the IPO does not proceed. Where provisions of the articles of association have been amended or removed during IPO preparation, reinstatement of the SHA would not automatically restore those provisions, and the necessary corporate approvals and actions would have to be undertaken separately. The agreement should also address the treatment of accrued rights and transactions validly completed during IPO preparation, ensuring that the agreed arrangements do not create uncertainty regarding the continuing obligations of the investors, company or its promoters.

Conclusion:

An IPO does not invalidate the commercial bargain originally negotiated between founders and investors, but it changes the framework within which that bargain operates. Rights negotiated to protect an investment may also influence corporate decisions, governance, access to information and the interests of other shareholders. Their reconsideration must therefore balance legitimate investor protections with the interests of incoming public shareholders, equitable treatment and the governance requirements applicable to a listed company.

There is no single contractual solution applicable to every right. Depending on its nature, terms and legal implications, a right may need to be exercised, fulfilled, waived, suspended, modified or brought to an end at an appropriate IPO milestone. While the law does not expressly require all special rights to terminate upon listing, the broader regulatory framework may require their modification or cessation. However, this does not give the company an automatic right to unilaterally terminate negotiated investor rights. Their treatment must be determined in accordance with the agreed contractual terms, applicable law and mutual agreement between the parties.

Any proposed post-listing entitlement must also be assessed under the applicable regulatory framework. As examined in our earlier articles, The Promoter Paradox — Part I& Part II, certain investor rights may have implications for the determination of control and, consequently, promoter identification. The issuer must therefore assess these rights as they operate at different stages of the IPO and ensure that any changes affecting its promoter classification are accurately reflected in the offer documents.

Equally important is the treatment of the agreed investor exit. A successful listing does not necessarily mean that the investor has realized its investment or that every contractual exit obligation has been fulfilled. The arrangements must therefore clearly address the rights and obligations applicable upon listing, as well as the protections, outstanding commitments and alternative exit mechanisms that may apply if the IPO does not proceed. Both outcomes should be supported by the necessary contractual and corporate arrangements. As discussed in our earlier article, Drafting for an Exit That May Fail, focusing solely on securing an exit at the investment stage may prove inadequate if the agreed mechanism later becomes legally or contractually unworkable and the consequences of its failure have not been addressed.

For issuers, investors, BRLMs and IPO advisers, three questions should be resolved before filing the DRHP: Who holds the material rights? What powers or obligations do those rights create for the company and its shareholders? And how will those rights be treated if the IPO succeeds, fails or does not achieve the agreed investor exit? The answers must be supported by the underlying agreements, corporate approvals and consistent offer-document disclosures.

Ultimately, IPO readiness is not established merely by including a termination clause in the agreement. It requires documented and legally sustainable treatment of the rights negotiated in the private investment bargain, through the IPO process and into the company's proposed listed-company framework.

Footnote

1. SEBI, Consultation Paper on Strengthening Corporate Governance at Listed Entities by Empowering Shareholders, 21 February 2023, paras 6.1.1-6.1.2 (S2).

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.