Shareholder Buy-Sell Agreements

Article by Joanne Cassidy

Do you really want to be in business with your partner’s ex-spouse? Or maybe have a competitor sitting at your board meeting?

If the answer is “no,” then you should consider a shareholder buy-sell agreement.

As a general rule, shares of stock are freely transferable. Shareholders can sell them, estates can distribute them to heirs in the probate of a deceased’s estate, and judges can award them to a spouse in a divorce action. However, shareholders can agree among themselves to restrict ownership only to the original shareholders and to those people they may later want to become shareholders.

A shareholder buy-sell agreement is a very effective mechanism for controlling who can and cannot become a shareholder of your company.

This is How a Shareholder Buy-Sell Agreements Works

1. Restrict the Transfer of Shares

A shareholder agreement restricts the transfer of shares, and provides a procedure for the shareholders to follow if a shareholder wants to sell his shares, dies, leaves the employment of the company, becomes disabled, gets divorced, or if his spouse dies. Not every Agreement deals with all of these eventualities and the shareholders can choose what events they want the Agreement to cover.

2. General Sale Procedure

The Agreement will typically provide a general sale procedure to be used in each triggering event. For example, if a shareholder wants to sell his shares, the agreement might require that he first offer his shares to the company. If the company does not agree to purchase his shares within a certain period of time, then he offers the shares to the other shareholders. If neither the company nor the other shareholders purchase his shares within a certain period of time, then he can sell his shares to an outside party.

3. Shareholder’s Estate

The same procedure is followed if a shareholder dies. In that case, his estate will be bound by the Agreement and will become the offering party.

4. Divorce of a Shareholder

Upon the divorce of a shareholder, it is possible for a court to award shares of stock to the non-shareholder spouse. The shareholder agreement typically provides that the divorcing shareholder has the first right to purchase the former spouse’s shares and the company and remaining shareholders have the right to purchase them if the divorcing spouse doesn’t.

5. Employee-Shareholder

Very often shareholders are also employees of the company. If an employee-shareholder becomes disabled or otherwise discontinues his employment with the company, the company may want to get those shares back so it can offer them to someone who has a direct investment in helping the company succeed. You also don’t want a former employee going to work for a competitor and still having a seat at your annual shareholder’s meeting.

6. Purchase Price

Purchase price is an important issue in every shareholder agreement and there are various methods by which the purchase price is calculated. Some Agreements require the shareholders to meet once a year to set the purchase price. Other Agreements require the purchase price be set by an appraiser. Still others use book value as a purchase price. While there are many ways to determine purchase price, every Agreement should be very specific about how the price will be determined so as to avoid price disputes when a triggering event happens.

7. Funding Purchase and Sale

Shareholders should consider how the purchase and sale will be funded. In some cases it may be appropriate to fund sale upon death with life insurance and sale upon disability with disability insurance. It may also be appropriate to specify an initial cash payment with the remaining amount of the purchase price being paid in installments over time.

8. Selling the Company

The Agreement should anticipate that at some time the shareholders might want to sell the entire company. The agreement can provide that if the majority of the shareholders want to sell, then the minority shareholders must sell and the majority must negotiate the sale for the minority on the same terms as it negotiates for itself.

9. Closing

The Agreement should detail what happens at closing. Typically, the stock certificates are transferred to the buyer and the cash and/or promissory note is transferred to the seller. If the purchase price is paid in installments, the buyer typically requires a stock pledge to secure payment. If the buyer fails to make payments, then the seller can get his stock back.

10. Spousal Agreement

All shareholders and their spouses and the company must agree to be bound by the terms of the shareholder agreement and each stock certificate should state that the stock is subject to a shareholder agreement that restricts the transfer of shares and that any stock sale in violation of the Agreement is void.

You insure your company against unforeseen liabilities. Shouldn’t you protect it against unwanted ownership?