Entrepreneurs looking to raise capital from investors should familiarize themselves with all key, customary legal documents. The Voting Agreement and Right of First Refusal and Co-Sale Agreement—along with other transaction documents like the Stock Purchase Agreement, Charter, and Investor Rights Agreement—govern the relationship between companies and their shareholders, and help to avoid potential conflicts or disputes in the future. These documents are complex and nuanced, requiring careful drafting and negotiation to balance the interests and expectations of the parties.
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What is a Voting Agreement?
The Voting Agreement outlines how the shareholders of your company will vote on matters such as the composition of the board of directors and certain sales of the company.
Key elements of the Voting Agreement
Board composition is often at the heart of any financing, as it determines who has the power and influence to run the company and make strategic decisions. The board voting provisions in the Voting Agreement specify who has the right to designate or appoint the directors, who the initial appointees are, and what conditions are required to maintain the right to appoint the directors. These provisions may vary depending on the size and structure of the board, the preferences of the investors and the founders, and the stage of the company. The Voting Agreement also provides for the removal and replacement of directors. When drafting, care must be taken to ensure alignment of the Voting Agreement with the company’s other organizational documents, like the charter and bylaws.
The other key component of the Voting Agreement is the “drag-along” right. A drag-along is the right of the majority of the shareholders or the board to force the sale of the company and require the minority shareholders to vote in favor of the sale and waive any appraisal rights. This right is important so as to avoid minority shareholders blocking or delaying a deal that the majority approves. These provisions also provide certain protections to the minority shareholders that are “dragged-along,” such as not requiring them to make representations or warranties about the company, not subjecting them to restrictive covenants, and not making them liable for indemnification beyond the amount they receive in the sale. The Voting Agreement also contains provisions to prevent transfers to bad actors or sanctioned parties, to comply with securities laws, and to lock up the shares in the event of an initial public offering.
What is a Right of First Refusal and Co-Sale Agreement?
The Right of First Refusal (or ROFR, for short) and Co-Sale Agreement give the company and the investors the right to buy or sell shares before a shareholder can sell them to a third party. This agreement typically applies to sales of common stock or non-equity securities that are convertible into, or exercisable for, common stock, such as options or warrants. Though not typical, in some cases it may also apply to sales of preferred stock. This agreement is intended to discourage third-party stock sales, prevent unwanted or unknown parties from becoming shareholders, maintain the alignment of interests among the shareholders, and provide some liquidity opportunities for the investors.
What is the ROFR?
The ROFR is the right of the company and the investors to purchase shares that a key holder wants to sell to a third party, on the same terms and conditions as the proposed sale.
The company has the primary ROFR, and the investors have a secondary ROFR, meaning that the company gets the first chance to buy the shares, and the investors get the second chance to buy whatever is left. The investors are also often granted an under-subscription right, which allows them to buy more shares than their pro rata portion if some investors do not fully exercise their ROFR. The ROFR is subject to certain exemptions, such as transfers to affiliates and transfers for estate planning purposes.
What is the Co-Sale Right?
The co-sale right is the right of the investors to sell their shares alongside the key holder to the third party, if the key holder is able to sell some or all of their shares after the ROFR process.
In a co-sale, the investors can sell their pro rata portion of the shares being sold, and they will receive the same consideration and terms as the key holder. The co-sale right also has some nuances, of course, such as whether the shares sold by the investors reduce or add to the number of shares the key holder can sell, how the consideration is allocated among the sellers, and how the liquidation preference of the preferred stock is protected. As always, care should be taken when drafting to reflect the intent of the parties, and to ensure consistency across the company’s documentation.