While diligently filing articles of incorporation and adopting bylaws, many corporate owners overlook a critical element of their business relationship: buy-sell, or buyout, provisions. By creating a shareholders’ agreement with buy-sell provisions, the owners of a small, privately held corporation can prepare for events that have been the downfall of more than a few successful small businesses – namely, the death, divorce, bankruptcy or retirement of one of the owners.
What Are Buy-Sell Provisions?
Contrary to popular belief, buy-sell provisions don’t have anything to do with buying and selling companies; instead, they control when and how shares in a corporation can be bought and sold. Shareholders include these provisions in a written document called a shareholders’ agreement or a buy-sell agreement. (Although you can also include these provisions in your corporate bylaws, it’s easier, and more legally sound, to create a separate agreement.) Typically, this agreement controls the following business decisions:
- who can buy a departing shareholder’s stock (this may include outsiders or be limited to other shareholders)
- what events will trigger a buyout (see the list below), and
- what price will be paid for a shareholder’s interest in the corporation.
It may help to think of a buy-sell agreement as a sort of “premarital agreement” between you and your co-owners.
What Events Should You Cover in a Shareholders’ Agreement?
Your shareholders’ agreement will instruct and remind you and your co-owners how you have agreed to handle the sale or buyback of shares from a shareholder whose circumstances have changed. Typically, the events that trigger a buyout of a shareholder’s interest are:
- an attractive offer from an outsider to purchase a shareholder’s interest in the corporation
- a divorce settlement in which a shareholder’s ex-spouse stands to receive all or part of a shareholder’s stock of the corporation
- the foreclosure of a debt secured by a shareholder’s stock
- the personal bankruptcy of a shareholder, or
- the disability, death or incapacity of a shareholder.
Why You Need a Shareholders’ Agreement
It’s a huge mistake to ignore the fact that sooner or later your business will change. If you doubt this even for a minute, think about what would happen if you don’t create a buy-sell agreement and one of the following occurs:
- One shareholder quits to move to another city or leaves to start another business. Without an agreement, you must decide whether you should buy out the departing shareholder’s ownership interest, and for how much. If you’re the shareholder who wants out, without an agreement you won’t be able to force your co-owners to buy you out.
- One shareholder dies, gets divorced or becomes mentally or physically incapacitated. In this case, you might have to work with the spouse or other family member of a deceased, disabled or divorced shareholder. There is a substantial possibility that the family member would be inexperienced or otherwise unable to act in the best interests of the business. On the flip side, you (or your family) might get stuck with a small business interest that no outsider wants to buy and for which no insider will give you a decent price.
- One shareholder sells his or her share to a stranger or to someone you know well and can’t stand. In this case, you may be forced to share control of the company with an inexperienced or untrustworthy stranger – or you’ll be faced with the struggle of running a business with someone you’d rather not even see on the street.
Just looking at this list, it should be obvious that if you don’t anticipate and plan for circumstances like these, you’re risking serious personal and business discord – perhaps even court battles and the loss of your business.
Creating a Shareholders’ Agreement
To create the buy-sell provisions for your shareholders’ agreement, you can use either a self-help resource or see a lawyer – or both. One good tool isHow to Create a Buy-Sell Agreement & Control the Destiny of Your Small Business, by attorneys Anthony Mancuso and Bethany K. Laurence (Nolo.com), which contains a disk with a fill-in-the-blank buy-sell agreement. Even for those who want the services of a lawyer, this book walks you through the necessary discussions with your co-owners, so you can decide on your own time – not your lawyer’s – which terms you want to include.