Organizing a new corporation can be a daunting task. While new owners are eager to begin providing and marketing their new product or service, they face a multitude of forms and details required to get underway. It’s tempting simply to focus on the bare minimum, the here and now, and, consequently, overlook one of the most important tools for your long-term success.
Laws and regulations don’t require buy-sell agreements, but securing and protecting your business interests do. Buy-sell agreements spell out what happens to shares when one of the shareholders leaves the company, detailing pricing and terms of payment.
Buy-sell agreements typically apply to corporations, but similar agreements are also recommended for partnerships and limited liability companies that involve more than just one owner. Such agreements are important because most people carefully choose their business partners, and they don’t want unknown third parties coming in, buying stock, reviewing the books and dictating the course the business should take.
Developing a good buy-sell agreement takes much discussion and time. Agreements should be customized to your company’s and shareholders’ unique situations, establishing different buy-sell terms for the many scenarios your company may face.
Most agreements will include five primary considerations.
#1 Trigger events. This details the circumstances to which the agreement applies. Business owners will want to consider (but not necessarily include) provisions for voluntary sale, involuntary sale, death, disability, divorce (in which a shareholder’s spouse is granted shares of stock) and bankruptcy.
#2 Valuation of shares. Perhaps the most difficult part of establishing buy-sell agreements is establishing the price of shares. One of the more common means for arriving at a price is for shareholders to determine the value each year at annual meetings. Theoretically, if you have all shareholders — each with an interest in their own shares and the success of the company — working together to establish the value, you can arrive at a fair price. Prices can also be based upon book value of the assets, a multiple of earnings, capitalized earnings or some other formula. Accountants can be valuable resources for helping you determine what makes the most sense for your company.
#3 Options/required purchases. It’s important to spell out who is entitled to purchase shares. You may want to stipulate that the shares are purchased by the corporation itself, that remaining shareholders are required to buy the shares or that remaining shareholders simply have first option to buy.
#4 Payment terms. When determining payment terms for purchasing shares, you may want to consider different terms for different trigger events. For example, if a shareholder leaves to join a competitor, you may want to buy them out (at a lower price) and pay them more slowly and at a lower interest rate. On the other hand, if a shareholder dies, you may wish to pay their estate quickly. If such a layout would be substantial, the company may benefit from having life insurance policies on its major shareholders, ensuring the cash is there when needed.?
#5 Enforcement. Even the best buy-sell agreements can be interpreted differently by different people, especially when it comes to valuation. It’s best to anticipate such differences by including a section regarding enforcement. Here you can stipulate how disagreements will be handled. Will you go to court right away, or will there be an attempt at arbitration? If you seek arbitration, will it be binding? As with any important business document, it’s important to seek help from professionals. Look for an accountant experienced in valuation and one who has a track record of helping companies in this regard. Likewise, you’ll want an experienced attorney to help you draft the buy-sell agreement that’s best for your business. Just as you would with your business partners, seek people whose judgment you respect and with whom you feel comfortable working.
Finally, remember that a good agreement will not only protect individual shareholders and their beneficiaries, but it will also protect the business, ensuring your hard work here and now will result in lasting impact and long-term benefits.
By Brandon Prinsen, Business Lawyer at Johns, Flaherty & Collins, SC. For a business lawyer or help with a buy-sell agreement, contact Brandon at 608-784-5678.