This slideshow outlines the more common elements of a shareholders' or buy-sell agreement.

1. Shareholders’ Agreements: An Overview of
the Basics
Presented by Bart Greenberg
Haynes and Boone, LLP
Tech Coast Venture Network Workshop
March 3, 2011
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2. WHO are the Parties?
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3. WHO Are the Parties?
• Company
– Responsible for enforcing restrictions on transfer
– Typically has rights under agreement, such as right
to acquire shares
• Founders
– To ensure Company continues to be owned by
people with whom they agreed to form Company
• Employees
– Required to become parties when they first acquire
stock
• exercise of a stock option
• receipt of a restricted stock award
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4. WHO Are the Parties? (cont.)
• New investors
– Often requires the execution of a shareholders’
agreement that imposes transfer restrictions on
shares owned by founder and other shareholders
• Spouses
– Typically required in community property states
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5. WHAT are the Primary Purposes?
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6. WHAT Are the Primary Purposes?
• Continuity
– Allow existing shareholders to maintain pro rata
interests
– Prevents stock from falling into unfriendly hands
(competitor, ex-spouse, etc.)
– Provides for orderly sale of shares by shareholder
who becomes disabled or ceases to be employed
• Management Control
– Voting agreements regarding board composition
– Other protective provisions
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7. WHAT Are the Primary Purposes? (cont.)
• Liquidity
– Can assure a source of liquidity to the estate of a
deceased shareholder
– Can assure a source of liquidity to minority
shareholders if majority wants to sell
– Can provide a mechanism for calculating the value of
the stock held by the decedent
• Subchapter S Election/Other Restrictions
– Can be used to prevent transfers that would cause
Company to no longer qualify as a Subchapter S
corporation
– Can restrict transfers to persons that would cause
Company to lose a license or approval
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8. WHAT are the Primary Provisions?
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9. Restrictions on Transfer
• Define Restrictions on Transferability
– Unreasonable restraints on alienation are void
– Include involuntary transfers by operation of law,
such as bankruptcy and divorce
• Define Scope of Permitted Transfers
– Family members and estate planning
– Distributions by institutional investors
• What is Consequence of Improper Transfer?
• What are Legend Requirements on Stock?
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10. Right of First Refusal
• Who Holds the Right?
– Founder
– New investor
– Company
– Other shareholders
• What is the Proper Procedure?
– Notice requirements
– Who gets to go first?
– How long to exercise?
– Who gets over-allotment?
– All or nothing?
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11. Right of First Refusal (cont.)
• Permitted Sales
– For how long can sales be made after compliance
with right of first refusal?
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12. Other “Triggering” Events
• Typical “Triggering” Events Include:
– Death or disability
– Termination of employment
– Divorce
– Other involuntary transfer
• Affected Shareholder (or Estate) Must Offer
to Sell Shares to Company and/or the Other
Shareholders
• Alternatively, Could Obligate Company
and/or the Other Shareholders to Purchase
the Shares
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13. Other “Triggering” Events (cont.)
• Considerations Upon Death of Shareholder
– Funding through key-man insurance
• Who Pays the Premiums?
• Who is the Beneficiary?
• Affect on Payment Terms?
– Preserve tax benefits of a “cross-purchase”
• Considerations Upon Divorce of Shareholder
– Direct judge to award equal value of other community
assets to shareholder’s spouse
– If other community assets are not sufficient, right to
purchase
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14. Determination of Share Value
• Right of First Refusal
– Typically, on the same terms and conditions offered
by the third party
– Exceptions: Fair market value or lesser of fair
market value and terms of third party offer
• Optional or Mandatory Purchase Upon a
“Triggering Event”
– There is no outstanding offer by a third party
– The following are the more typical valuation
methodologies:
• Periodic determinations by board or shareholders
• Determination by application of a formulaic approach
• Determination by independent, third party appraisal
• Agreement of the parties
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15. Terms of Purchase - Closing
• Right of First Refusal
– Typically, on the same terms and conditions offered
by the third party
– Exceptions: See Below
• Optional or Mandatory Purchase Upon a
“Triggering Event”
– Typically, provisions for cash down payment and
balance to be paid by promissory note
– Be aware of restrictions on repurchasing stock as
follows:
• Insolvency and related Chapter 5 code restrictions
• Covenants in debt or other financing documents
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16. Certain Liquidity Provisions
• Co-Sale or Tag-Along Provisions
– Instead of exercising the right of first refusal, other
shareholders can participate in certain sales (usually
tied to a minimum percentage interest) to the third
party up to their respective pro rata interests
• Drag-Along Provisions
– Allows certain shareholders (usually tied to a minimum
percentage interest) to force other shareholders to sell
– Consider impact, if any, on liquidation preferences set
forth in Company’s charter documents
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17. Certain Liquidity Provisions (cont.)
• Double Shot-Gun
– Shareholder offers to buy-out co-shareholder
– Co-shareholder then has the option to either:
• Accept initiating shareholder’s offer
• Buy-out initiating shareholder on same terms and
conditions
• Compare with California Corporations Code
Section 2000
– Only applicable in a 50/50 situation
– Affected shareholders may avoid dissolution action by
initiating 50% shareholder(s) by purchasing initiating
shareholder(s)’ stock at fair market value
– Application may be waived in charter documents
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18. Voting Agreements
• Number of Directors
• Designation of Directors
– Voting agreements by class
– Removal and resignations
• Grant of Irrevocable Proxies
• Other protective provisions
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19. Termination of Agreement
• Company Sale
• Liquidation or Dissolution
• Initial Public Offering
• Voluntary Agreement to Terminate
– Executed by all parties to agreement; or
– Executed by holders of certain percentage of stock
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20. WHERE Else Could These
Provisions Be Used?
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21. WHERE Else Could These Provisions Be Used?
• Charter documents
– Advantages:
• Automatically applies to all stock issued after the adoption
of the restriction
• More likely to be enforceable in the event of bankruptcy
– Disadvantages:
• Prevents individual deals and customization
• Option or Stock Purchase Agreements
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22. WHEN is the Right Time to Put a
Shareholders’ Agreement in
Place?
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23. WHEN is the Right Time?
• Formation
– Makes sense for single shareholder company to
implement
– Always easier to implement before a “triggering” event
• Subsequent financing
– New investors will typically require a shareholders
agreement to be in place as a condition to making their
investment
• Other Circumstances
– Death of Founder
– Business has changed in material manner
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24. Presentation of Case Study
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25. Questions?
Bart Greenberg
Partner
18100 Von Karman Avenue, Suite 750
Irvine, California 92612
bart.greenberg@haynesboone.com
949.202.3037
25
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