Stockholders’ Agreement

A Stockholders’ Agreement, also known as a Shareholders’ Agreement, is a legally binding contract among the stockholders of a company. Primarily concerned with governing the relationship between the company’s stockholders, the agreement also governs the way in which the company is managed, sets terms and conditions on ownership of company stock, and protects the interests of individual stockholders. The overall purpose of a Stockholders’ Agreement, like most agreements, is to minimize disputes between its signatories, in this case by setting forth rules for fair treatment of stockholders and proper management of the company. For example, these agreements frequently contain provisions on the purchase and sale of stock, protocols for conducting key business and making decisions affecting the rights of stockholders, mandatory actions to be taken in the event of a stockholder’s death, incapacity, or exit from service to the company (typically in the case of an employee or executive), and other similar provisions.

Key Provisions

1. Buy-Sell Provisions: One of the most critical elements of any Stockholders’ Agreement is the inclusion of buy-sell provisions, or “buyout” provisions. Often referred to colloquially as a “business pre-nup,” these clauses dictate what happens to a stockholder’s stock if they wish to exit the company, die, or become incapacitated. Buy-sell provisions sometimes also include language governing scenarios in which a stockholder is forced out of the company, providing a clear method for calculating the value of shares and who may purchase them.

2. Control and Management: These provisions detail management of the company and how decisions will be made, including the appointment of directors to the company’s board, and the delegation of management responsibilities. Control provisions also discuss voting rights, often detailing the sorts of decisions requiring a supermajority of votes–or unanimous consent–instead of just a simple majority.

3. Pre-emptive Rights: Pre-emptive rights, also commonly referred to as “anti-dilution provisions,” allow existing shareholders the first opportunity to buy new shares of stock issued by the company, thus enabling them to maintain their proportionate ownership of the company and prevent dilution.

4. Drag-Along and Tag-Along Rights: Also commonly referred to as “drag/tag,” these rights deal with events surrounding the sale of the company and work in opposite ways. Tag-along rights protect minority stockholders in the event of a sale of the company. In the event that a majority stockholder sells their stake in the company, the minority holders have the right to join the transaction and sell their stock under the same terms as were received by the majority. Drag-along rights function in the opposite way, giving a selling majority stockholder the right to force minority stockholders to join in a sale of the company at the same terms, thus facilitating cleaner transaction.

5. Dispute Resolution: Stockholders’ Agreements often contain rules and procedures for resolving stockholder disputes, including through mandatory mediation and/or arbitration, among other means.

Benefits

Stockholders’ Agreements aren’t strictly necessary for any company. They are, however, highly advisable for any company with more than one stockholder (i.e., most startups and larger companies). The agreements provide a clear framework for governance and decisionmaking, giving stockholders much needed predictability, stability and direction as their companies’ organizational structures and cap tables grow increasingly complex. Furthermore, to investors, a well thought out Stockholders’ Agreement tends to make investment more attractive, as it demonstrates that the company is well-managed and that the risks of shareholder conflict are minimized.

Conclusion

A Stockholders’ Agreement is an essential tool for both large and small companies, and particularly startups. It ensures that stockholders are on the same page regarding how the business is run, how their rights are safeguarded, and how disputes and other issues will be handled. By clearly defining the roles, responsibilities, and rights of stockholders, a Stockholders’ Agreement can pre-empt conflict and pave a solid path forward for startups and other companies. Stockholders’ Agreements are often long and complex, however, and it is advisable for companies thinking about implementing a Stockholders’ Agreement to consult with competent legal counsel to draft and tailor an agreement according to their specific preferences and requirements.