By Maurie Cashman
A Buy-Sell Agreement can be one of the single most important documents that you will sign. We discussed several reasons for its importance last week.
This week, letâ€™s look at how these agreements can protect rights among shareholders, provide a way for joint owners to clarify a common vision of the future of the business, and establish a market for an ownerâ€™s stock at an agreed-upon price.
â€œThe most savage controversies are those about matters as to which there is no good evidence either way.”
—Bertrand Russell, British philosopher, logician, mathematician and historian
Buy-sell agreements establish and protect rights among shareholders that otherwise would not exist in the company.
Through a buy-sell agreement, a minority shareholder may attain more control over his or her destiny than is normally provided through voting rights. These safeguards may include placing limits on the sale or purchase of the stock of the majority owner(s), establishing valuation of all ownersâ€™ stock, giving minority owners the right to sell their stock if certain events occur, and other important items.
An example of the type of right that a buy-sell agreement can establish is providing the owner of a minority interest the right to serve on the board of directors. This can be an important right because otherwise, a minority shareholder might not be able to gather enough votes to be elected to the board.
Secondly, it is important to require the corporation and remaining shareholders to do their best to obtain the release of the departing shareholder from any personally guaranteed indebtedness, as well as to release any personal collateral used for a corporate debt when the owner of that collateral sells his or her interest in the company. In difficult economic times you can expect banks and other creditors to be reluctant to release personal guarantees and collateral without more than adequate replacement value.
Last week, we discussed the George Swift and Iowa Advertising, Inc. case study. As a minority owner, George was unable to buy control of the company and was unable to prevent a new majority owner from exercising total control over the company. A buy-sell agreement could have prevented that.
Buy-sell agreements force owner communication
Owners rarely sit down together to discuss their opinions about questions such as: What happens if one of us dies? What happens if we stop getting along? What happens if one wants to retire before the other? What happens if one of us becomes incapacitated? In order to create a buy-sell agreement, owners are forced to address these important questions.
Letâ€™s look how this discussion played out for Darci and Henry, equal partners in a fictional software business.
Darci and Henry had a rocky relationship and assumed that the other held opposing views about future growth of the business and about the desires of each to remain in the business. They each had their own opinion about their respective value to the company.
They understood that they needed a buy-sell agreement. It was while meeting with their advisory team to create a buy-sell agreement that they recognized the many reasons for their companyâ€™s success. Although Darci was the â€œinvestorâ€ and Henry was more active in the business, they learned that both were equally concerned with the long-term future of the company. This recognition provided the foundation to develop a buy-sell agreement for their mutual benefit.
The drafting process took months. During that time, Darci and Henry met periodically with their advisors to review business goals and aspirations. They found common ground, not just in matters contained in the buy-sell agreement, but also with respect to operational ideas. Those bases of agreement soon became a consensus on how the business should proceed if one of them were no longer involved.
As a result of this contemplative process, Henry and Darci became more committed to the business and the companyâ€™s profitability and value increased steadily.
A buy-sell agreement establishes a market for an ownerâ€™s stock at an agreed-upon price.
Without an agreement, thereâ€™s no market for stock in a closely held business, even if youâ€™re a controlling owner. Your ability to sell your interest will be limited unless you can require your co-owner to also sell (Most buyers donâ€™t want the potential excess baggage of a co-owner they didnâ€™t choose).
If you have not made firm arrangements for the sale of your stock, the buy-sell agreement is the only means of disposing of your ownership interest at a fair price. The agreement can obligate other owners to purchase your stock, thus creating a market if you must sell your stock due to unforeseen events.
There are many advantages to a buy-sell agreement. If you have any questions about how to talk to your co-owner about creating a strong business continuity agreement for your company, please contact us to discuss your particular situation.