When one person is co-investing in a business with another, there will typically need to be an agreement between the parties regarding their ownership and control of the business. This may be called a shareholder agreement, LLC agreement, operating agreement, or joint venture agreement, depending on how the business is legally organized. Regardless of its name, the key terms of such an agreement are typically similar, and include the following. (Note that venture capital backed corporations typically have a unique set of equivalent documents, described in further detail here.)
Closing
The procedure for the investment itself (funding, issuance of equity interests, and the like) may be set forth in the shareholder or joint venture agreement, but there will often be a separate agreement, such as a stock purchase agreement, to deal with the closing process, especially if the business is an existing business. This is because the existing owners will usually be required to give representations, warranties, and indemnities regarding its present state at the time the new investor comes on board, and this is easier to handle in a separate agreement.
Capital and Funding
There will typically be procedures for the business to obtain additional funding through common or preferred equity contributions from the shareholders, shareholder loans, and third-party financing such as bank loans. This gives the investors control over the process and prevents dilution of their equity interests.
Management
The details of the management structure depend upon how the business is legally organized. If it is a corporation, there will typically be annual general meetings of shareholders where directors are elected, and then the board of directors will elect officers. The shareholders will typically agree that they each have rights to nominate a certain number of board members and to nominate certain officers, and to vote in favor of each other’s nominees. The governance structure may be simpler if the business is organized as a partnership, LLC, or other type of entity.
There will usually be a list of matters over which investors have veto rights, or over which certain super-majority votes of investors are required, in order to protect the value of their investments.
Transfer Restrictions
The parties will sometimes agree that neither party may sell their stake without the other party’s consent, but this locks the parties into the arrangement for what can be an extremely long time. A common compromise is to allow an investor to sell their stake, provided that they first give the other investor(s) an opportunity to buy it through a right of first offer or right of first refusal.
Deadlock
Especially in an agreement with strict transfer restrictions, it is necessary to consider what will happen if the parties cannot agree on how to manage the business (to the extent their agreement is required). These “deadlock” provisions typically involve options for the parties to buy each other out at a valuation determined by a third-party referee, or through a pre-determined process such as a “shoot-out” (where both parties bid, and the higher bidder has to buy the other party’s share at their bid price).
Termination
These agreements typically do not terminate except in specific instances where the joint venture relationship ends, such as an investor selling all of its interest, the business winding up its operations, or an investor going bankrupt.