My Co-Founder Is Leaving: How His Shares, Directorship and Loan Come Back

A co-founder exit from a private limited company does not happen by itself. His shares stay his until a signed transfer form in Form SH-4 is registered under Section 56 of the Companies Act, 2013, or the company buys them back under Section 68, and nothing in the Act takes them away because he stopped working. His directorship ends only on a written notice of resignation under Section 168, followed by the company's DIR-12 filing within thirty days. Money he lent the company is a debt that survives his exit. A promise not to compete after he leaves is void under Section 27 of the Indian Contract Act, 1872. Everything else is negotiation, and the paper that closes it is a co-founder separation agreement.

Part of the corporate and commercial law practice at S Jain & Attorneys, Bangalore.

This guide is for the founders who remain in a Bengaluru private limited company on the standard model articles, with no founders agreement and no vesting, a departing co-founder holding 30 to 50 percent who sits on the board, and a loan from him on the books. It does not cover ESOP holders, a non-resident founder whose transfer attracts FEMA pricing rules, or a founder being removed for fraud.

The co-founder exit checklist

Seven things have to be closed. This table gives what the law says about each, the instrument that does it and the clock that runs.

Key takeaway. Leaving the business returns nothing. Until he signs a transfer form or tenders into a buy-back, a departed founder with 30 percent still receives every notice, still votes, and still defeats every special resolution, because Section 114 needs three votes in favour for every one against.

Three facts drive every decision that follows.

My co-founder is leaving: do his shares come back to the company automatically?

No. Shares are his property and the Companies Act has no provision that returns them because the holder has stopped contributing. Section 44 calls them movable property transferable in the manner provided by the articles. The standard model articles provide a way to transfer shares, not a way to lose them. Forfeiture under the articles is a remedy for unpaid calls. Reduction of capital under Section 66 needs a special resolution and the Tribunal's confirmation. Neither is a leaver mechanism.

What founders usually mean by shares coming back is reverse vesting: the founder receives his full holding on day one, and the company or the other founders hold a right to buy the unvested portion at a nominal price if he leaves early. That right exists only if a document creates it: a signed agreement with a call option, a trigger, a price formula and a mechanism for signing the transfer form if the leaver will not, mirrored in the articles so that the company can lawfully refuse to register a transfer that breaks the scheme. Our note on the founders agreement for a startup sets out what that clause looks like when drafted in time.

The reason the articles matter is a Supreme Court decision that still governs. In V.B. Rangaraj v V.B. Gopalakrishnan, decided on 28 November 1991, the shareholders of a private company had agreed among themselves that each branch of the family would sell only within its own branch. The articles said nothing of the kind. When one shareholder sold outside his branch, the Court held that an agreement imposing restrictions on transfer beyond those in the articles was not binding either on the shareholders or on the company, and dismissed the suit. If your only paper is a WhatsApp thread and an unsigned draft, there is no leaver mechanism, and the exit has to be negotiated.

Can we force him to sell his shares?

Not without a signed obligation to sell. The articles of a private company must restrict the right to transfer shares, because Section 2(68) requires it, and the usual form of that restriction is a power in the board to decline to register a transfer. That power is defensive. It can stop him selling to an outsider you do not want as a shareholder. It cannot make him sell to you.

Even the defensive power has a procedure. Under Section 58(1), when a private company refuses to register a transfer it must send notice of the refusal, with reasons, to the transferor and the transferee within thirty days of the instrument being delivered. Under Section 58(3) the transferee can appeal to the Tribunal within thirty days of that notice, or within sixty days of delivery if no notice was sent. A refusal without reasons, or one designed to trap him so that he sells to you cheaply, is the kind of decision the Tribunal reverses.

A right of first refusal exists only where the articles contain it, and the model articles do not. Nor can you dilute him out. A rights issue under Section 62(1)(a) must be offered to every equity holder in proportion, with a right to renounce, and a preferential allotment under Section 62(1)(c) needs a special resolution, which he blocks above 25 percent, and a registered valuer's price. An issue engineered to punish a founder is the opening allegation of the petition described in our guide to oppression and mismanagement at the NCLT.

Should the founders buy his shares, or should the company buy them back?

In most exits the remaining founders buy the shares personally under Section 56, because a buy-back under Section 68 is a company-wide exercise whose conditions rarely fit a one-person exit.

Common mistake. Treating a buy-back as a tool for buying one person's shares. Section 68(5) and Rule 17 of the Companies (Share Capital and Debentures) Rules, 2014 make the offer proportionate to all shareholders, and the company cannot withdraw the offer once it is announced. A buy-back works for a founder exit only when the other holders are willing to sit out, the reserves exist, and no Section 70 default is open.

What price do we pay for a co-founder's shares?

Whatever the two sides agree, because no section of the Companies Act fixes the price of a private transfer between Indian residents. The Act imposes a price only where the company itself is a party to the deal. A preferential allotment to a new investor under Section 62(1)(c) must be priced on a registered valuer's report, and Rule 13 of the Share Capital Rules says the issue price cannot be less than that valuation. A buy-back must state the price and the basis of arriving at it in the explanatory statement under Rule 17. Where the Tribunal orders one side to buy the other out, it works from fair value, and our note on share valuation in NCLT buy-outs explains how that number is built.

Founders still get a report from a valuer registered under Section 247 for a negotiated exit. It anchors the number, and it protects both sides on tax, because a transfer of unlisted shares below fair market value has income-tax consequences for the seller and the buyer under the Income-tax Act, 2025, so a chartered accountant has to run the figure before the SH-4 is signed. The report also settles what the ESOP pool is worth, which matters if the leaver is counting it as part of his stake. Our note on ESOP legal issues in a startup covers why the pool is not his.

Payment terms are where the deal is really negotiated: instalments with the shares in escrow until the last one, a pledge of the transferred shares in his favour, or a lump sum funded by the company repaying his loan on the same day. The founders owe the price. The company owes the loan. Keep the two ledgers separate.

How does he stop being a director?

He resigns in writing to the company under Section 168(1), the board takes note of it, and the company files Form DIR-12 with the Registrar within thirty days of receiving the notice under Rule 15 of the Companies (Appointment and Qualification of Directors) Rules, 2014. Under Section 168(2) the resignation takes effect on the date the company receives the notice or the later date he names in it. He may, but since the 2017 amendment need not, file his own copy with reasons in Form DIR-11 within thirty days under Rule 16. The board's report at the next general meeting must record the resignation.

Two things follow. The proviso to Section 168(2) keeps him liable for offences committed during his tenure, so his release clause cannot promise otherwise. And a private company must have at least two directors under Section 149(1)(a), so if he is one of only two, appoint the replacement first and the board is never below strength.

Deadline warning. Two clocks run from the day the papers are signed. DIR-12 is due within thirty days of the company receiving his resignation. The SH-4 must be delivered to the company within sixty days of its execution under Section 56(1), failing which the board can register the transfer only on such terms as to indemnity as it thinks fit. Sign, file and lodge in the same week.

If he will not resign, Section 169(1) lets the company remove a director by ordinary resolution after giving him a reasonable opportunity of being heard. It is a last resort, and the Registrar's record will show a removal rather than a resignation, but a 30 percent holder cannot block an ordinary resolution on his own. The same week, pass the board resolutions that take him off the bank mandate, the GST and income-tax portals, the provident fund and ESI logins and the MCA account. Section 168 changes the register. It does not change who can move money.

He put money into the company: do we have to repay him before he leaves?

You have to repay him on the terms on which he lent it, and if nothing was written, the company owes the money and he can call for it. His exit neither accelerates the debt nor extinguishes it. It changes the negotiating table: he wants the loan back and you want the shares, and the separation agreement is where the two are traded.

The compliance point most founders miss is the deposit rules. Under Rule 2(1)(c)(viii) of the Companies (Acceptance of Deposits) Rules, 2014, an amount received from a person who, at the time of the receipt, was a director of the company is not a deposit, provided he gave the company a written declaration at the time that the money was not borrowed from others, and the company disclosed the loan in the Board's report. The test is applied at the moment the money came in, so his later resignation does not turn the loan into a deposit. If no declaration was ever taken, the money may be a deposit accepted outside Section 73, which must be fixed before any buy-back, because Section 70(1)(c) bars a buy-back while a deposit default subsists and for three years after it is cured.

The settlement can repay the loan at closing, reschedule it with interest, run the repayment and the share price on the same day so that the two net off, or record a waiver, which is a write-back in the accounts with tax consequences that a chartered accountant must price first. Whatever is chosen, state the loan balance as on a fixed date, or every reimbursement in the ledger will be disputed later.

Can we stop him from starting a competing business?

Not by a clause. Section 27 of the Indian Contract Act, 1872 makes every agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind void to that extent. The single statutory exception protects a buyer of the goodwill of a business, who may take a covenant from the seller within specified local limits. A founder selling shares is not selling goodwill, and whether a share sale can be brought within that exception is contested ground no founder should build a plan on. The case law, including decisions refusing to enforce a post-exit restraint the employer had paid for, is in our note on whether a non-compete clause is enforceable in India.

What survives is narrower and more useful: a confidentiality clause that identifies the information, the repositories, the customer data and the pricing models, a non-solicitation clause covering named customers and current employees, enforced on proof of actual solicitation, and an IP assignment that removes his ability to reuse the product. The commercial protection is speed: close the assignment and the handover before he has a reason to build the same thing again.

Who owns the code, the brand and the domain he built?

He does, unless he was an employee or has assigned it in writing. Section 17 of the Copyright Act, 1957 makes the author of a work its first owner. Proviso (c) shifts first ownership to the employer only for a work made in the course of employment under a contract of service, and a founder who drew no salary and signed no employment contract is often not an employee at all. Anything he wrote before incorporation was written for a company that did not exist. The result is that the codebase in a two-founder startup frequently belongs, on paper, to the developer founder personally.

The cure is an assignment that meets Section 19: in writing, signed by the assignor, identifying the work and specifying the rights, the duration, the territory and the consideration, which can be the share price itself. Section 18 allows an assignment of copyright in future works, so one deed covers everything he wrote for the venture and anything he finishes during the handover. Do the same for the trademark: if the application stands in his personal name, the mark is his until an assignment is signed and recorded with the Registry. Then list the accounts, domain registrar, GitHub organisation, cloud consoles, app store, payment gateway, social handles, email admin, and transfer each on the closing date with credentials rotated the same hour. Our guide to IP protection for startups covers the fuller inventory.

What if he will not sign anything?

Then he remains a shareholder and a director until the law removes each status, and your remedies depend entirely on whether a signed obligation exists. As a director he can be removed under Section 169. As a shareholder he keeps everything: the financial statements under Section 136, his proportionate entitlement in every rights issue, and his vote, which above 25 percent is a veto on special resolutions.

Where a signed founders agreement or shareholders agreement obliges him to sell on leaving, the obligation is enforceable by a suit for specific performance. Since the 2018 amendment, Section 10 of the Specific Relief Act, 1963 says specific performance shall be enforced by the court, subject only to Sections 11(2), 14 and 16, and the old discretion to refuse it is gone. Section 14 still excludes a contract so dependent on personal qualifications that the court cannot enforce its material terms and a contract determinable in nature, but an agreement to sell a fixed number of shares at a fixed formula is neither. The Supreme Court in M.S. Madhusoodhanan v Kerala Kaumudi, decided on 1 August 2003, held that the company need not be a party to an agreement for the transfer of issued shares for it to be specifically enforced between the parties. An arbitration clause sends the same claim to an arbitrator, with interim relief under Section 9 of the Arbitration and Conciliation Act, 1996 to freeze the shares meanwhile. Our note on the key clauses of a shareholders agreement explains how the clause is made to bind the company as well.

Where no signed obligation exists, the Tribunal is not a buy-out machine for the majority. A petition under Section 241 needs conduct prejudicial or oppressive to a member or the company, and Section 244 opens it to holders of one tenth of the issued capital, which a 30 to 50 percent founder comfortably is. A squeeze-out attempt hands him the facts, and Section 59 rectification lets him undo a transfer registered without a valid instrument. The honest advice in a no-paper exit is to agree a price. A deadlocked company with two 50 percent holders who no longer speak is the outcome every other route risks.

What goes into the co-founder separation agreement?

One document, signed by the company and every founder, that closes all seven items at once. The clauses that carry the weight are these.

• Parties and recitals: the company, the leaving founder and each remaining founder, with the shareholding, directorship and loan balance stated as on a named date.
• Share transfer: number of shares, price, who buys how many, the SH-4 executed at signing, delivery of the certificate, and the board's undertaking to register the transfer.
• Payment: dates, instalments, escrow or pledge until the last instalment, and what happens to unpaid shares if the founders default.
• Resignation: the letter annexed, the effective date, the company's DIR-12 undertaking, and his DIR-11 if he chooses.
• Loan: the agreed balance, the repayment, rescheduling or waiver, and the accounting treatment both sides accept.
• IP assignment: a Section 19 compliant assignment of all past and future work for the venture, identified by repository and project, plus trademark and domain transfers.
• Handover: the list of accounts, credentials, devices and documents, and the date each changes hands.
• Confidentiality and non-solicitation: identified information, named customers, current employees, a stated period.
• Mutual release: each side releases all claims from the relationship, including salary, reimbursements and unpaid promises, with the company joining in.
• Continuing liability: an acknowledgement that Section 168(2) keeps him answerable for his tenure, and an indemnity that is honest about what the founders will cover.
• Non-disparagement, each party's own tax, and a dispute clause naming arbitration seated in Bengaluru or the courts here.
• Stamping and execution: the agreement stamped under the Karnataka Stamp Act, the SH-4 stamped at the central rate for share transfers, and wet-ink or digital signatures.

Step by step: closing a co-founder exit

1. Pull the articles, the register of members, the share certificates, the loan ledger and every message about the exit, and check whether any signed document contains a leaver, vesting or transfer clause.
2. Agree the headline terms in writing: who buys the shares, at what price, what happens to the loan, and the resignation date.
3. Commission a registered valuer's report and have a chartered accountant run the tax on the transfer price and on any loan waiver.
4. Draft the separation agreement with the IP assignment, the resignation letter and the SH-4 as annexures.
5. Hold a board meeting to note the resignation, approve the transfer subject to lodgement, appoint any replacement director and change the bank mandate and portal signatories.
6. Sign everything on one day: the agreement, the SH-4 with the stamp duty paid, the IP assignment, the resignation letter. Pay the first instalment against the signed set.
7. File DIR-12 within thirty days of the resignation and lodge the SH-4 with the certificate within sixty days of execution. Endorse the certificate and update the register within one month of lodgement.
8. Rotate every credential on the handover list and confirm the trademark and domain transfers are recorded.
9. Repay or reschedule the loan as agreed, and record the disclosure in the next Board's report if the loan continues.
10. Keep the closing set, with the valuation report and the stamped SH-4, in the statutory records. The next investor's lawyer will ask for exactly this file.

What does a co-founder exit cost, and how long does it take?

An agreed exit closes in three to six weeks and costs a fraction of a contested one. The figures below are indicative.

Stamp duty on the SH-4 is the uniform central rate for a transfer of securities on a delivery basis, 0.015 percent of the consideration, in force since 1 July 2020, and a transfer without consideration attracts no duty on the form. The separation agreement carries Karnataka stamp duty as an agreement. Registrar fees for DIR-12 and, in a buy-back, SH-8, SH-9 and SH-11 are published on the MCA fee tables and are modest. A registered valuer's report for an early-stage company commonly runs from the tens of thousands of rupees to a few lakhs. Drafting and closing an agreed exit is usually a fixed fee. A contested exit runs into lakhs and a year or more.

The timelines that the law fixes, and the ones it does not, sit side by side.

Mistakes founders make in a co-founder exit

The same errors recur, each cheap to avoid before signing and expensive after.

• Treating a message that says he is out as a resignation. Section 168 needs a notice in writing to the company and a board noting with a date, because DIR-12 and the effective date run from it.
• Paying him before the SH-4 and the IP assignment are signed. Money paid against a promise to sign is money spent on a lawsuit.
• Using a buy-back to target one holder, then discovering the offer is proportionate and cannot be withdrawn.
• Skipping the valuation to save a fee and handing both sides a tax problem on a below-value transfer.
• Forgetting the personal guarantee he gave the bank on the company's loan, which is released only with the bank's written consent, usually against a replacement guarantor.
• Signing a release that binds only the founders, so that the company remains free to sue him and he remains free to sue the company.

Where these exits actually get stuck

What I tell founders at the first meeting is that the law gives them fewer levers than they expect and the leaving founder fewer than he expects, and the exit is settled by whoever understands that gap first. The remaining founders cannot take the shares. The leaver cannot take the company, and above 25 percent he cannot be ignored either. Where these cases turn is almost never the price. It is the sequence: whether the IP assignment was signed before the last rupee moved, whether the loan was written down as on a date, whether DIR-12 went in on time, whether the bank mandate changed the same week. A short agreement that closes all seven items in one sitting beats a long one that leaves two for later.

Frequently Asked Questions

This article is for general informational purposes only and does not constitute legal advice. Consult a qualified advocate for advice on your specific situation.

Related Guides

A co-founder exit sits at the meeting point of company law and contract drafting, which our corporate and commercial law practice handles from Bengaluru, and it often surfaces the IP questions our intellectual property practice deals with.

• Founders Agreement for Startups in India: The Complete Guide
• Shareholders Agreement in India: Key Clauses Explained
• ESOPs in an Indian Startup: The Legal Issues Founders Miss