In today’s business climate, businesses cannot afford to make mistakes. Yet there is one legal mistake that many small and medium-size businesses often make – they don’t have a buy-sell agreement in place. This can create several big issues. For example, without an agreement in place, a business owner may wake up one morning to find out that a stranger owns part of his business. An owner that is getting ready to retire may find out that he can’t force his company to buy his stock. And, perhaps most troubling, the majority owner of a company who wants to sell his or her business may find out the sale is vetoed by his minority shareholders.
These problems can all be avoided if a proper buy-sell agreement is in place. Who needs such an agreement? The answer to that question is easy – any small or mid-sized company that has more than one owner really needs a solid buy-sell agreement. It doesn’t matter whether you are a corporation, partnership or limited liability company. If there is more than one shareholder, partner or member, an agreement should be in place.
The agreement should cover a number of areas. For example, many companies provide stock to employees. Because many people are having economic trouble, they will try to sell this stock. Without an agreement, they are free to sell it to whomever they want. Or, let’s say they are fired. Just because they lose their job, they are not required to sell the stock back to the company. And a disgruntled former employee can create a lot of headaches as a minority shareholder, such as challenging the compensation paid to a majority owner.
The agreement should also address what happens when an owner retires, becomes disabled or dies. This is often a critical time for both the shareholder and the company. If an agreement is not in place, a minority shareholder may be able to block the purchase of the stock of the retiring or deceased shareholder. In addition, the agreement should include the necessary terms, such as drag-along rights, that make sure a majority owner can sell the business he or she has built. Statutes in many states and standard provisions in many governance documents, such as operating agreements, allow minority shareholders to block a sale of assets or stock, but these can be overcome with an appropriate buy-sell agreement.
The agreement should address several detailed items in addition to providing protection for the events described above. For example, if one of the triggering events occurs, must the corporation buy the stock or does it have an option to do so? How will the value be determined – by a preset agreed upon amount, by a formula, or by appraisal? How will the purchase be funded? Will the company be obligated to buy insurance or create a sinking fund? If the price will be paid over time, what are the terms, including the amount of the down payment, the length of the payout, and the interest rate? Will the remaining shareholders guarantee the payout?
On a final note, the use of form buy-sell documents can be dangerous. A buy-sell agreement must be carefully tailored to fit the specific situation. In addition, it should be integrated with the business owner’s estate plan. Most importantly, it needs to be in place before an issue arises. A well drafted buy-sell agreement is a “must have” document for small and medium-sized businesses.