A shareholders’ agreement is a legally binding contract that may be entered into between the company and one or more of its major shareholders. Sometimes called an investor rights agreement, it sets forth the rights and obligations of the company’s shareholders. A shareholders’ agreement may be entered into in a variety of contexts, such as to explicitly outline the rights of key shareholders of a startup or to outline the rights of a private equity sponsor ahead of an initial public offering. The agreement is intended to provide major shareholders with enhanced protections, such as information rights, voting rights, and consent rights over specified corporate actions.

There are a number of customary provisions in shareholders’ agreements. The agreement often begins with a definitions section, which contains relatively standard definitions for certain terms. For example, “Person” is defined broadly to include “any individual, firm, corporation, partnership, limited liability company, joint venture, association, trust, estate, governmental authority, or other entity.” The definition of the term “transfer” is often also relatively standardized, capturing “any direct or indirect sale, donation, exchange, assignment, pledge, hypothecation, mortgage, gift, grant of a security interest or other transfer, disposition, or encumbrance.”

The shareholders party to the shareholders’ agreement are typically granted consent rights over certain corporate actions, provided that their ownership of the company’s stock is still above a specified threshold percentage (e.g., at least 25%). Such “Major Actions” are often defined to include approving any changes in the size of the board of directors, entering into transactions for the purchase of assets above a certain value (e.g., at least $100 million), incurrence of any indebtedness in a principal amount above a certain value (e.g., at least $150 million), and authorizing the payment of dividends.

A shareholders’ agreement may also grant shareholders owning above a specified threshold percentage of the company’s stock (e.g., at least 50%) with the right to appoint a director to the board. Alternatively, major shareholders may be granted a right to appoint a non-voting board observer. Such an individual would be invited to attend all board meetings in a non-voting observer capacity and would have to agree to keep the information learned confidential.

There are usually provisions in the shareholders’ agreement covering the transferability of shares. Some shareholders’ agreements contain tag-along and/or drag-along rights. In the event of a sale of the company’s shares by the majority shareholders, the drag-along rights would provide the majority shareholders with the power to compel the remaining minority shareholders to sell their shares on the same terms being granted to the majority shareholders.

Tag-along rights are the inverse of drag-along rights. Tag-along rights provide minority shareholders with the opportunity to participate in a sale of the company’s shares on the same terms being granted to the majority shareholders. Tag-along rights are sometimes referred to as co-sale or piggyback rights. Relatedly, there may be a right of first refusal (ROFR) in the shareholders’ agreement. A ROFR provision obligates the majority shareholders to first make an offer to the remaining minority shareholders to sell their shares on substantially identical terms. If the remaining minority shareholders turn down the offer, only then can the majority shareholders proceed to sell the company’s shares to a third party.

Information rights are another common feature of shareholders’ agreements. If shareholders own above a specified threshold percentage (e.g., at least 5%), they are granted access to certain non-public information about the company. Such information rights may include access to the company’s books and records, monthly management reports, and capital expenditure budgets.

Drafting a shareholders’ agreement requires consideration of a number of factors, including the nature of the relationship between the company and its major shareholders. The rights, responsibilities, and obligations of the parties in a shareholders’ agreement should be negotiated with careful attention to detail and an understanding of the future implications of such provisions.