These agreements are between a corporation and its shareholders and relate to the purchase of shares of corporate stock. There are numerous matters that are generally addressed in these agreements, but, in general, they establish and document the investor’s suitability for investing in the corporation.
These agreements are an integral part of good corporate governance and record-keeping. They are approved by the board governing the corporation (Board of Directors) and keep track, at a minimum, of the number of shares issued, the valuation methodology for shares and corresponding share price, and the total amount paid for all shares of stock issued.
Subscription agreements are a contract and, as such, may contain additional provisions such as a specified rate of return to the investor, non-dilution of interest provisions, non-competes, non-disclosures, confidentiality, buy/sells, and drag along/tag along provisions, among other matters.
Why Subscription Agreements Are Important and When to Use Them:
The substance of these agreements for single-member or multi-member small business operations is very simple and straightforward. They are, however, necessary when providing financial statements and filing tax returns.
If you are ever going to look for outside financing for your corporate endeavors, however, you will need to have these agreements ready as a part of the due diligence for the financing; particularly, they are necessary for proving compliance with applicable federal and state securities laws, an element of complexity not necessary for small businesses.
Common Subscription Agreement Terms:
- Buy-sell agreements are the corporate equivalent of a prenuptial agreement. They apply when and if (i) one of the shareholders wants to leave; (ii) a group of shareholders want to force another shareholder out; (iii) a shareholder dies; or (iv) a shareholder becomes disabled. When these events happen, the remaining shareholders can use the terms of the buy-sell agreement to calculate the amount of money the exiting shareholder’s investment is worth and to provide the terms and conditions for payout. The point is that the business gets to continue and the departing shareholder or the departing shareholder’s estate has liquidity.
- Drag-along provisions are negotiated in advance and allow a majority shareholder or group of shareholders to require a minority shareholder or group of minority shareholders to join in the sale of a company. These require the majority shareholder to give the minority the same price, terms, and conditions as any other seller.
- Confidentiality agreements, also called non-disclosure agreement, requires an employee of a corporation to not share confidential information acquired during the employment relationship. These are generally found in an employment relationship, but can also occur in a variety of other circumstances such as intellectual property development. The non-disclosure applies to the time of the employment and for a certain period after employment ends.
- Non-compete agreements occur when a corporation requires that an employee not compete with the business. These generally restrict the activities of an employee only after they leave the company and prohibit the employee from opening or investing in a competing business for a certain period of time within a certain geographic zone.
- Tag-along provisions are also negotiated in advance; however, in this instance, the minority shareholders have the right to “tag-along” with the majority sale. These rights do not require a minority shareholder to sell, but instead give the right to tag along and sell their shares along with the majority shareholder.