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Sep 26

Don’t Forget the Buy-Sell Agreement

A buy-sell agreement is often overlooked when a corporation is being formed because it is geared towards an event that may (or may not) happen at some time in the future. If, however, you do not have one when that time arrives, it may leave your business scrambling for answers and solutions. A smart corporate lawyer will make sure you know your legal options regarding a buy-sell agreement and are well prepared for any eventuality.

WHAT IS A BUY-SELL AGREEMENT?

A buy-sell agreement can be included in your corporate by-laws.  It can be part of a larger agreement between or among the corporation’s shareholders.  In many instances, it is a standalone document.  No matter where it is found, a buy-sell agreement sets the standards for the selling or transferring of the shares of stock in a closely held corporation.  It is meant to ensure that the corporation itself or the other shareholders have the first opportunity to purchase the stock.  There are several occasions when this may occur.  A shareholder may desire to leave the corporation and pursue another endeavor.  He or she may decide to retire.  A shareholder may become disabled or die with the shares in his or her possession. A buy-sell agreement ensures that there is a definite procedure in place when these events arise.

WHY YOU SHOULD HAVE A BUY-SELL AGREEMENT?

A buy-sell agreement will prevent a host of problems that you might not contemplate when you form your corporation.  Let’s say that you have a corporation that has four equal shareholders, each of whom have a certain responsibility within the corporation.  What happens if one of the shareholders wants to resign and take a job outside of the corporation?  Should he still be able to share in the equity and profits of the business even if he  is no longer participating?  There may be a situation when a shareholder passes away.  Should that shareholder pass his interest to his spouse or children making them a decision-maker in the corporation’s operations?  A buy-sell agreement will set the terms and conditions by which the corporation or its shareholders may purchase the shares of the departing shareholder or the heirs of a deceased shareholder.  It provides for a smooth transition with little, if any, disruption to the day-to-day affairs of the corporation.  It will avert disputes between the shareholders.  If the document is drafted properly, it will reduce or completely eliminate the likelihood of a trip to court to decide how this situation should be resolved.

WHAT SHOULD YOUR BUY-SELL AGREEMENT INCLUDE?

A properly drafted buy-sell agreement will:

  • Enumerate all of the various circumstances under which the agreement is needed—departure, disability, retirement, death, etc.
  • Give the corporation, or its shareholders, the option to purchase the shares in question before anyone else, should one of the triggering events occur.
  • State that if a shareholder desires to divest his shares, it cannot be done without first offering the shares to the corporation and to the other shareholders.
  • Include a time period for the offer and acceptance. This will prevent the transition process from extending over a long period of time.
  • Include the procedures that will be in place in the event that a sale to a third party is permitted when the corporation and the shareholders do not want to make the purchase. (Corporations often have a reserve fund or take out insurance to provide for situations such as this.)
  • Include a method for determining the price that will be paid for the stock. Some agreements require that the price be set on a yearly basis.  There can be a formula included in the agreement that will be used by the parties to set the price.
  • Provide for when the funds will be paid, how the shares will be transferred to the new shareholder and the process for updating the corporate records making the transfer official, once the price has been determined.

In addition, the buy-sell agreement may:

  • Require the new shareholder to abide by the terms and conditions of any previous agreements between or among the shareholders.
  • Provide for a method of resolving disputes relating to the buy-sell agreement. This may include mediation and/or arbitration, as either an interim procedure before going to court or as a method to completely resolve any such disagreements.
  • Provide for a majority of the shareholders to approve any transfer.
  • Give the current shareholders the first right to acquire newly issued shares of the corporation’s stock.
  • Provide a procedure for amending the terms of the buy-sell agreement. This usually entails that the amendment  be in writing and specifies the percentage of shareholders necessary to make the amendment official.

Contact a San Jose Corporate Attorney

Experienced corporate attorneys know that a buy-sell agreement is easy to overlook at the outset of your corporation’s existence, but that you will never regret having one later when questions arise.  Business partners enter into a relationship with good intentions, but disagreements over money can derail even the strongest collaborations. A buy-sell agreement can alleviate many concerns before they become problems that result in bad feelings, litigation or both. If you would like to talk about your particular situation with a savvy San Jose corporate lawyer, contact us by phone or email to schedule a free initial consultation.