Need For A Buy-Sell Agreement

You have formed a closely held corporation or limited liability company. The shareholders or owners are also likely employees of the business. You perceive yourselves as “partners.” Do you want your fellow shareholders to be able to transfer their shares freely to outsiders, making the transferee a new “partner” in the ownership and management of your enterprise? If not, you need a buy-sell agreement to limit the transferability of the shares in the business.

The subject of transferring shares arises in a number of ways: upon an owners death, disability, retirement, voluntary resignation from employment, involuntary termination of employment (firing) or bankruptcy, as well in the case where the owner or shareholder just wishes to cash out or to sell shares to a third party.

In situations where the shareholders are active in the business, all parties often wish someone who is no longer an employee to cease being a shareholder as well.

This, in turn, leads to three difficult questions: Who will be the buyer? At what price? and On what payment terms?

Options Restricting Share Transfer

New Jersey generally will not enforce absolute restrictions on the transfer of shares. Thus, it is not acceptable for the shareholders to agree never to transfer their shares.

Often, the limit placed on transfers is in the form of a first offer. Under this plan, if a shareholder wishes to dispose of his or her shares, he or she must first offer the shares to the business. If the company does or cannot take them up, than to the other individual shareholders at a price and on specific terms pursuant to the agreement. The agreement can provide that the corporation and the shareholders must purchase the shares, or simply that they have an option to purchase.

In drafting your agreement, there are a number of variations possible. They need to be discussed and understood.

In the case of events that could happen and trigger the transfer of business interests, such as disability or death of an owner, the first question to be answered by the agreement is whether the event creates a mandatory sale. The alternative is an option to buy on the part of the corporation or other shareholders, or an option to sell on the part of the shareholder. The alternatives depend on many considerations. Again a full discussion is in order.

Determining Share Selling Price

There are several ways in which the selling price of the shares can be established. It can be based upon book value, an agreed value, a formula, an appraisal, or it can be based on an arbitration process. There are several factors which must be taken into account in setting the price and determining the method used to establish the price of the stock. An example is the effect of the loss of a key person to the company and the goodwill and earning capacity of the company without that person.

In addition, when seeking to establish the price of stock to be set by the buy-sell agreement, one should also consider tax consequences. There are difference considerations in life and following death. In order for the buy-sell agreement to fix the value of stock for estate tax purposes, there are specific criteria in the drafting of an agreement that must be met.

Funding of Stock Purchase

The buy-sell agreement also establishes the terms of payment when any of the events occur which trigger a stock purchase situation. Such terms may include an all cash purchase or a down payment plus installment payments with or without interest. If there are to be installment payments there may be requirements relating to the operation of the business until the last payments are made. For example there may be limits of payments in salary etc. to remaining owners. There may be limits on expanding or borrowing. There are tax consequences to how the installments are set up.

Another provision you want to consider in the buy-sell agreement is a provision for the purchase of life insurance policies by the corporation, the stockholders, or both, on the lives of the shareholders whose stock they may be required to purchase. You must ask, if two or more shareholders die within a short period of time, would the corporation or the remaining shareholders have the capital immediately available to purchase the deceased shareholder’s stock?

Conclusion

A buy-sell agreement can serve to keep the control of your business in the hands of the initial shareholders. It can prevent control falling into the hands of third parties, perhaps even competitors.

We invite you to contact us for a confidential consultation to discuss the particulars of your situation.