Should You Have Founder Shareholder Agreements?

Most high growth companies that are set up for venture capital funding don’t use a stockholder agreement

We sometimes get asked whether founders should put in place a “stockholder agreement” at the time of formation.  People have different practices but in my experience most companies do not use a stockholder agreement at the time of formation.

By way of background, when you form a company, the applicable state corporate law (typically Delaware) provides a number of default rules for governing the corporation, and the bylaws of the corporation implement and embody many of these. For example: how directors are elected, whether stock is transferable, who are the officers of the company, how are shares voted, etc.  In addition, we will usually put in place vesting agreements with the founders that define how the stock is earned and when it will be forfeited if the person leaves the company.  (This is itself a form of “stockholder agreement” because it binds each founder to the Company and therefore to the other founders, although it’s an agreement between each individual and the company.)

For most companies, these default rules, agreements and the trust between founders is sufficient and they do not incur the expense of drafting a separate, stand-alone stockholder agreement.  However, people sometimes decide for various reasons that it would be sensible to put in place an agreement between the founders to cover what happens in certain defined situations.  While these types of agreements could theoretically cover any number of situations, here are the things you most often see covered by these agreements:

1. Governance: how is the board elected and who will be the officers.
2. Transferability of shares:  will the company or any other stockholder have a first right to buy stock that is proposed to be transferred by a stockholder?  Will the other stockholder have a right to participate (or “tag along”) in sales by a stockholder?
3. Buy-outs:  are there situations where the company or other stockholders can buy out a stockholder, such as death, disability, or termination from the company?  If so, what is the price and how is it determined?

It’s important to note that once the Company raises VC funding, any stockholder agreement will be replaced by a new set of agreements requested by the investors.  So be sure you don’t put in place an agreement that cannot be modified at the time of the financing or you could find yourself stuck.  An example of this would be if the agreement required all parties to agree to an amendment but one of the founder parties has left the company before the financing and is not cooperative.