By Maurie Cashman
There are several uninsurable ownership transfer events; for example, the bankruptcy or divorce of one of the shareholders. In the event of one of these involuntary transfers, the shareholder could be forced to transfer his ownership interest (in the case of bankruptcy to the bankruptcy trustee or creditor or in the case of divorce, to the former spouse.) You may want your buy/sell agreement to simply give the business the opportunity to acquire the shareholdersâ€™ stock. You may insist on creating this provision when you contemplate the prospect of having your co-ownerâ€™s ex-spouse as your new co-owner!
This is in contrast to business continuity solutions to the problems that arise when an owner dies, which is insurable. Last week, we introduced the idea of using business continuity planning to resolve the ownership transfer events that can occur during your lifetime. These issues include:
- Dispute between or among owners leading to sale of ownership;
- Termination of employment by Company;
- Sale to an outside party
- Involuntary transfer due to Bankruptcy or Divorce Decree;
- Permanent disability;
For example, permanent disability is usually funded by insurance. In this way, it is very similar to the death of a shareholder. As you plan for this possibility, you may have to spend time carefully defining “permanent disability” so that your company does not suffer from an owner who doesnâ€™t realize how incapacitated she really is.
Letâ€™s look briefly at the sale to an outside party. A buy/sell agreement should include restrictions on transferring stock to non-owners. Without this provision, the agreement lacks the restrictive requirements necessary to achieve its primary goal. Without a well-crafted agreement, an owner would be able to transfer his stock to anyone, at any time, thereby avoiding the agreementâ€™s primary purpose of restricting ownership to current owners.
If ownership interest is to be offered to an outsider, the agreement normally requires the owner to first offer his interest to the company, then to the remaining co-owners at the same price and terms offered by the would-be buyer.
Often the agreement requires that the purchase price offered the remaining owners be the lower of the value set forth in the agreement or the price offered by the would-be purchaser. This assures the remaining owners that they need pay no more than the value fixed in the agreement.
Sometimes it is advantageous to structure a buyout agreement to attract a specific outside buyer to buy into the company at some future date. There may be a key employee, family member or outsider with whom the company has a significant relationship that would be beneficial for both the outside party and the owner to have as part of the ownership structure. This can be an important part of extending the life of a business by bringing in a new owner to replace the skill of an owner who desires to retire or remove some of the risk of ownership of the business at some point.
Finally, several of the lifetime transfer issues listed above are voluntary because they are in the control of one or more of the shareholders. For example, if there are two equal owners, one of whom is President, you may want your agreement to prevent the President from being able to fire the other owner. Imagine instead that there are three equal shareholders. Two of them would generally have the power to fire the third. In that event, the two might want the ability to purchase the terminated ownerâ€™s stock. The fired owner may want the ability to sell his stock back to the company. Or, all owners may simply want the agreement to require a mandatory purchase of stock in the event of termination of employment of a shareholder for any reason, whether she is fired or quits.
To those owners who resist spending the time and money to think about these issues and to create a buy/sell agreement to address them, imagine what the litigation that will arise in these situations will cost, both financially and emotionally. To agree upon a means of assessing fair market value, the buyout terms and conditions before emotions rise and in advance of any need can prevent disastrous results.
We promote transferring the ownership of your business on Your Terms. Do you OWN YOUR RESPONSE or does it own you?