Why Business Owners Need Buy-Sell Type Agreements
August 10, 2023 | Carole Clark Isakson
Most businesses are structured as a type of corporation, limited liability company, or partnership. In many cases, a small business owner will undertake to set up the entity himself, taking advantage of the online documents available at the Secretary of State’s office. However, not all the documents necessary to have a fully formed entity are available through the Secretary of State – be aware that if all you complete are Articles, you’ve only created a shell of an entity (see my prior blog on this topic). Read on to understand why business owners need buy-sell type agreements.
The importance of buy-sell agreements
A corporation can be fully formed by filing Articles of Incorporation, getting an Employer ID Number (EIN) and entering into Bylaws, Subscription Agreements and opening minutes of the Shareholders and Board. A limited liability company can be fully formed by filing Articles of Organization, getting an EIN, and entering into an Operating Agreement, Subscription Agreements, and opening actions of the Members (and possibly others). A partnership requires a partnership agreement and possibly public filings, depending on the type of partnership. The Secretary of State does not provide all these forms, but even if it did, for an entity with more than one owner there is another document that really should be done – a document that governs how and when the owners can transfer ownership interests among themselves or to third parties. That type of an agreement is commonly referred to as a “buy-sell” agreement, or a shareholder agreement. For ease of reading, I’ll use the term “buy-sell” in this blog.
What is a buy-sell?
A buy-sell is an agreement among the owners of a corporation that governs how shares can change hands. It will usually restrict transfers, and provides that in some key listed events, shares will be made available first to the other shareholders or the entity itself. These types of provisions should be included in an Operating Agreement for a limited liability company, and in the partnership agreement for a partnership, so having them in a stand-alone buy-sell agreement is generally found in corporations only. This is one reason they seem to be frequently missed.
Why should you have a buy-sell?
When you decide to create an entity and start a business with another person, the assumption is that you and that person(s) have intentionally chosen each other for the business venture. Neither of you wants to be surprised by a new owner, so a key initial provision in buy-sell agreements is generally that no shareholder can transfer or pledge shares without the consent of the other shareholder(s). Exceptions may be included for revocable trusts done for estate planning purposes. To oversimplify, a buy-sell agreement identifies various events (called “triggering” events) that will trigger the rights of the company or other shareholders to buy the shares of the shareholder that triggered an event. The buy-sell will also set out the price to be paid under the various scenarios, and the payment method (i.e. all the payment need not be up front).
Common triggering events:
1. Death – If a shareholder dies, the company or other shareholders will want his or her shares, and not to have a spouse or children owning the shares. Generally, payment would be made to the estate for the value of the shares.
2. Retirement – If a shareholder wants to retire, should she be able to keep the shares?
3. Termination of Employment – Does a shareholder need to be an employee? If so, does termination of employment mean the shares should be transferred back to the company or other shareholders?
4. Disability – What is the impact of that on share ownership? Buy-out?
5. Involuntary Transfers – If a shareholder files for bankruptcy, is sued or during a divorce how does the company avoid having those shares go to a third party? This can be covered in the buy-sell as well.
6. Proposed Sale to a Third Party – What if a shareholder just wants to sell his interest?
These discussions are best to have when you are first creating an entity. The attorneys in the corporate department at BGS discuss these issues with every new entity being formed with multiple owners. If your company is already formed and your documents do not contain buy-sell provisions, we encourage you to contact one of our attorneys to take care of this important document. Contact Carole Clark Isakson, Scott M. Hagel, or Pedro Herrera.