When forming a new technology company, there are very few documents as important (and unfortunately, as overlooked) as a Shareholders’ Agreement. The discussion in this post is couched as an agreement among shareholders of a corporation but the same principles apply to members of a limited liability company and partners of a partnership.
The founders of a company rarely have differences of opinion, nor are the relationships among the shareholders acrimonious, at the beginning of a new venture; however, as time passes, divergence of opinions often arise and various events can (and do) occur that cause reasonable minds to differ. A Shareholders’ Agreement is an effective way to handle these situations.
Here are some (but not all) of the provisions that a Shareholders’ Agreement should include:
A. Right of First Refusal. Every Shareholders’ Agreement should contain a right of first refusal, in case one of the shareholders receives an offer from a third party to purchase his or her stock. If there are more than two shareholders, each non-selling shareholder usually may purchase his or her pro rata portion of the shares. The right of first refusal is an equitable way to permit a shareholder to cash out, but to protect the company and other shareholders from having unwanted shareholders.
B. Transfer Upon Death, Dissolution or Liquidation. In contrast to the voluntary transfer described above, involuntary transfers may be triggered by a shareholder’s death, divorce or bankruptcy. In each instance, a company may end up with undesirable shareholders. The Shareholders’ Agreement should give the company and the other shareholders the option to buy the shares on these occurrences.
C. Election of Directors/Voting Agreements. A Shareholders’ Agreement sometimes provides how many Board seats there will be and who has the right to be elected to these seats.
D. Preemptive Rights. “Preemptive rights” refers to the right of a shareholder to purchase enough shares to maintain his percentage ownership in the company if the company issues additional shares. A preemptive rights provision is also sometimes included in a Shareholders’ Agreement.
E. Purchase Upon Termination. If shareholders of the company are also employees, provisions giving the company the option to purchase their shares when their employment ends, either voluntarily or involuntarily, are important.
F. Proprietary Information/Non Competes. Shareholders’ agreements should require that all shareholders will maintain the company’s proprietary information in confidence. In addition, a Shareholders’ Agreement should include a provision that all intellectual property relating to the business of the company created by the founders, either before or after the creation of the company, will belong to the company. Finally, a shareholders’ agreement should prohibit the shareholders from competing with the company while they own an interest in the company and the shareholders should consider whether the non-compete should extend to some reasonable period of time, scope and geographic area after they no longer hold an interest in the company.
There are numerous other provisions that may be included in a Shareholders’ Agreement, including provisions relating to a company’s S-corporation status (if applicable), unanimous board/shareholders’ approval for certain events, co-sale rights, “tag along/drag along” provisions, and other corporate governance type provisions. The provisions of the Shareholders’ Agreement should be reviewed closely with your attorney.