Voting Agreements and Right of First Refusal / Co-sale Agreements in Venture Financing: Ultimate Review Guide

Venture financing deals usually involve the signing of the following documents:

  1. Term Sheet: The term sheet is a non-binding document outlining the basic terms and conditions under which an investment will be made.
  2. Share Purchase Agreement (SPA): The SPA is a central document in any VC deal. It sets out the specific terms of the transaction, including the number of shares being sold, the price per share, and the total investment amount. This agreement also covers representations and warranties, conditions to closing, and indemnification provisions
  3. Disclosure Schedule for SPA: This schedule accompanies the SPA and provides specific disclosures related to the representations and warranties in the SPA. It often includes exceptions or additional details that qualify or explain these representations and warranties, which are vital for assessing risks and obligations.
  4. Voting Agreement: The voting agreement details how certain shareholders must vote their shares, particularly in the context of board composition, sale of the company, and other major corporate decisions. It's essential for maintaining investor rights and balancing interests among different shareholder classes.
  5. Investor Rights Agreement (IRA): This document outlines various rights and privileges granted to investors, including rights to information, registration rights, and other governance-related matters.
  6. Right of First Refusal / Co-sale Agreement: This agreement provides the company, and sometimes other shareholders, the right to buy shares before the selling shareholder can transfer them to a third party (Right of First Refusal). It may also allow shareholders to join in on a sale (Co-sale).
  7. Certificate of Incorporation: Outlining the rights and privileges associated with preferred stock, which is commonly issued to venture investors.

In this guide, we will focus on the Voting Agreements and Right of First Refusal / Co-sale Agreements. Our goal is to provide comprehensive guidance for effectively reviewing, negotiating, and advising on the Voting Agreements and Right of First Refusal / Co-sale Agreements in a VC deal.

Voting Agreements in Venture Financing

Purpose and Implications

Voting Agreements are integral in defining the governance and decision-making processes within a startup. They typically lay out the modalities for voting rights attached to shares, especially in decisions crucial to the company's future. These agreements can significantly influence control dynamics, particularly in decisions like electing board members or approving major corporate actions.

Key Review Points for Voting Agreements

  1. Shareholder Classes and Voting Power:
    • Investors' Preference: Institutional investors often prefer voting rights proportional to their investment, sometimes seeking additional rights for major decisions.
    • Company's Preference: Founders typically aim for voting structures that maintain their control, especially over board composition and strategic decisions.
    • Review Focus: Scrutinize the balance of power. Ensure that voting rights are distributed in a way that reflects both the investors' protection and the founders' operational control.
  2. Board Composition and Decision-Making Process:
    • Investors' Preference: Preference for board seats or significant influence in board decisions, especially in financial and operational matters.
    • Company's Preference: Retention of control over board composition to ensure alignment with the company’s vision and strategy.
    • Review Focus: Examine provisions for appointing, removing, and replacing board members. Pay attention to clauses that may lead to deadlocks or impede decision-making.
  3. Protective Provisions for Minorities:
    • General Preference: Both founders and investors may seek protective provisions to safeguard minority interests, such as veto rights on certain decisions.
    • Review Focus: Ensure there are clear guidelines on what decisions require minority approval and the process for such approvals.
  4. Drag-Along and Tag-Along Rights:
    • Investors' Preference: Drag-along rights to compel minority shareholders to join a sale, maximizing the deal’s attractiveness to potential buyers.
    • Company's Preference: Tag-along rights ensuring founders can participate in profitable exit opportunities.
    • Review Focus: Assess the fairness and balance of these rights, considering potential exit scenarios and the interests of all parties.

Right of First Refusal / Co-sale Agreements

Purpose and Implications

Right of First Refusal (ROFR) / Co-sale Agreements are essential in managing changes in company ownership. They give existing shareholders (or the company itself) the right to purchase shares before they are sold to an external party (ROFR), and/or allow shareholders to join in the sale of shares by another shareholder (Co-sale).

Right of First Refusal/Co-sale Agreements Review Points

  1. Trigger Events and Process:
    • Investors' Preference: Broad trigger events for ROFR to maintain control over the shareholder base.
    • Company's Preference: Flexibility in allowing shareholders to transfer shares, especially for small transactions or within certain groups (like family).
    • Review Focus: Identify and evaluate the specific events triggering ROFR/Co-sale rights. Ensure the process is practical, clear, and not overly restrictive.
  2. Pricing Mechanism and Valuation:
    • General Preference: Fair and transparent pricing mechanisms, often linked to market value or recent investment rounds.
    • Review Focus: Scrutinize the valuation method for share transfers under these agreements, ensuring they reflect current market conditions and are equitable.
  3. Exemptions and Limitations:
    • Investors' Preference: Limited exemptions to maintain control over the shareholder base.
    • Company's Preference: Certain exemptions for practicality, like transfers for estate planning or to affiliates.
    • Review Focus: Balance the need for control with practical considerations, ensuring exemptions are not exploited to circumvent the agreement’s spirit.
  4. Impact on Shareholder Liquidity:
    • General Concern: How these agreements affect the liquidity of shares, particularly for minority shareholders.
    • Review Focus: Assess the impact of these agreements on the ability of shareholders, especially minorities, to sell their shares. Ensure there's a fair opportunity for exit.

Related Articles:

  1. Term Sheet in Venture Financing: Ultimate Practical Review Guide (https://www.legalnowai.com/pages/term-sheet-in-venture-financing)

  2. Share Purchase Agreement: Ultimate Practical Review Guide (https://www.legalnowai.com/pages/share-purchase-agreement-review-guide)

  3. Investor Rights Agreement (IRA) in Venture Financing: Ultimate Practical Review Guide (https://www.legalnowai.com/pages/investor-rights-agreement-review-guide)

  4. Certificate of Incorporation in Venture Financing: Ultimate Practical Review Guide (https://www.legalnowai.com/pages/certificate-of-incorporation-agreement-review-guide)