Founders and early investors in any multi-stockholder corporation should enter into a Stockholder Agreement, which governs how the company will be operated, outlines stockholder rights and obligations, and ensures that stockholders are treated fairly. This Blog discusses the key components of Stockholder Agreements.
- Management Control Provisions
The provisions described below can streamline management, ensure that minority stockholders have a voice in management, and reduce the adverse impact of disputes.
• Director/Manager Appointment Rights. A voting agreement to appoint one or more directors designated by specified stockholders, allows such stockholders to maintain representation on the board even if they do not have a controlling vote. Such director appointment rights can terminate on certain events, such as the failure of a stockholder to provide full-time service to the company or the transfer of some portion of their shares.
• Dispute Resolution Provisions. Disputes between directors or stockholders can deadlock operations. Stockholder Agreements should incorporate simple and quick dispute-resolution procedures. The most common is mandatory, binding, expedited arbitration, however, the quickest and least expensive is an agreement that any disputes shall be resolved by a neutral pre-designated third party, such as the company’s accounting firm.
• Special Approval Rights. Approval rights for specified corporate actions, such as the incurrence of debt in excess of a specified amount, certain capital expenditures and officer compensation over a specified threshold, provide management with the flexibility to effectively operate the business while providing minority stockholders with the right to approve major decisions and corporate actions.
2. Transfer Restrictions.
The provisions below restrict and, in certain circumstances, compel, the transfer of securities.
• Rights of First Refusal. A right of first refusal requires a stockholder proposing to sell its shares, to offer the company, and then the other stockholders, the first right to purchase their equity prior to consummating a sale to a non-insider.
• Tag Along Rights. Tag-along rights provide minority stockholders with the right to participate in the sale of securities by other stockholders which results in a change of control, in the same proportion and on the same terms as offered to the majority stockholders.
• Drag Along Rights. Drag-along rights allow the selling stockholders to compel minority stockholders to sell their shares on the same terms and conditions offered to the majority stockholders in connection with a change of control transaction. Without drag-along rights, minority stockholders could block a sale, and/or leverage their minority position to negotiate a disproportionate share of the purchase price.
• Buyout Provisions. Buyout provisions allow the company and the other stockholders to purchase stock held by another stockholder if an unresolvable dispute arises between the stockholders, or upon the death, bankruptcy or divorce of a stockholder.
• Market Standoff Agreement. If a company files to go public, its underwriters generally require insiders and significant stockholders to agree not to sell shares within a defined period of time following the IPO. Incorporating a market standoff agreement within a Stockholder Agreement eliminates the need to track down early stockholders, and negotiate with existing stockholders who may be unwilling to execute a market standoff prior to an IPO.
The information contained in this article is strictly for educational purposes and is not intended to be legal advice or to be relied upon by anyone without doing their own research. If you have questions regarding shareholder agreements, operating agreements and partnership agreements, you can contact Jeffrey Marks at (949) 887-8877.