Subscription Agreement

A formal agreement between a company and an investor to buy shares of a company at an agreed-upon price

What is a Subscription Agreement?

A subscription agreement is a formal agreement between a company and an investor to buy shares of a company at an agreed-upon price. The subscription agreement contains all the required details. It is used to keep track of outstanding shares and share ownership (who owns what and how much) and mitigate any potential legal disputes in the future regarding share payout.

 

Subscription Agreement

 

Subscription agreements are important to understand when analyzing business partnerships and being an early owner, employee, or investor in a start-up.

 

Summary

  • A subscription agreement is a formal agreement between a company and an investor to buy shares of a company at an agreed-upon price.
  • It contains all the details of such an agreement, including Outstanding Shares, Shares Ownership, and Payouts.
  • A well organized and well-structured subscription agreement will contain details about the transaction, the number of shares being sold and the price per share, and the legally binding confidentiality agreements and clauses.

 

How Do Subscription Agreements Work?

Subscription agreements vary depending on the company they pertain to and the reason they are developed. Often, they will contain the details on a predetermined rate of return on the initial investment by a new investor into a company. It could be a percentage of corporate profits after the company passes certain agreed-upon financial milestones.

Subscription agreements generally occur at earlier stages with start-ups before companies are able to access venture capital or securities lawyers to take the company public. A well organized and well-structured subscription agreement will contain the details about the transaction, the number of shares being sold and the price per share, and the legally binding confidentiality agreements and clauses.

 

How They Are Regulated

The graphic below shows the legal methods governing subscription agreements in the United States:

 

Subscription Agreement - Governance
Source

 

Why Would A Company Choose Subscription Agreements?

Subscription agreements are chosen for a few different reasons. They are primarily done because the company is not yet at a point where they can attract venture capital or investment banks to invest in their organization. The agreements are also done to raise money from private investors without registering with the Securities and Exchange Commission (SEC).

 

Advantages of a Subscription Agreement

  • Generally are limited partnerships without any personal liability
  • One-time lump sum investment instead of ongoing venture capital contributions
  • Able to invest early and watch your investment grow as the company scales up
  • Can provide a positive voice and influence with company leadership

 

Disadvantages of a Subscription Agreement

  • Lack of voting rights 
  • Requires a large lump-sum contribution, instead of traditional equities that can be purchased in lower dollar share amounts
  • No liquidity: Once funds are invested, you must find someone to buy you out, which can be difficult to do
  • Lack of transparency and oversight without the SEC involvement
  • Legal issues that can arise if proper counsel is not used to examine and advise on the deal

 

Related Readings

CFI is the official provider of the Capital Markets & Securities Analyst (CMSA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Common vs. Preferred Shares
  • Limited Liability Partnerships (LLPs)
  • Non-Disclosure Agreement (NDA)
  • Shareholders’ Agreement

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