Drafting a buy-sell agreement can be very confusing. You want to make sure that you include all necessary terms to ensure that you are covered in any circumstance. There are also questions that you should ask during the drafting of the contract, to ensure that the contract correctly reflects your intentions.
Terms that Should be Included
Provision should prohibit transfer of interests and provide that such transfers are invalid unless the transfer is a type permitted under the agreement.
If certain types of transfers are to be permitted, the types of transfers that are permitted should be identified in the agreement. (Ex. with consent of shareholders or to authorized parties such as family.)
Voluntary Lifetime Transfer of Interest
If an interest may be transferred, and such transfer may be made to an outsider, the provision may provide other interest holders or the company with the option to match the offer made by the outsider. Some further terms may include:
- Notice of Proposed Sale. Provision would require the interest holder to notify the other interest holders of the price and terms of the offer by a third party.
- First Option to Other Owners. Provision would give other interest holders the option to purchase that interest first.
- Default of Option by Shareholders. Provision would provide what would happen if no interest holders choose to exercise their option to purchase.
Helpful in the case of divorce or bankruptcy, to prevent business interference from outsiders, the other owners should have the option to compel the affected owner to sell his shares to the remaining owners or the entity itself.
Sale of Shares on Death
This provision should provide information on the time for payment, whether there is a mandatory obligation by the entity or other owners to purchase the interest; and provide information on any potential life insurance requirements.
Transfer on Total Disability
This provision should define what a disability will be.
Transfer on Termination of Employment
This provision should define what will happen with terminated employees.
Purchase of Interest
Other shareholders or corporation may either have an option to purchase shares upon the occurrence of a triggering even or an obligation to purchase shares upon such an event.
- Entity redemption arrangement. Business entity is obligated to purchase the owners interest. Entity can purchase life insurance policy.
- Cross-purchase arrangements. Each surviving owner of a business becomes personally obligated to purchase the departing owners interest. Each owner has a life insurance policy on the lives of the other owners.
- Hybrid Agreement. Purchase may be made by the company or other owners.
Identification of persons, other interest holders, or the corporation who have the option to purchase. May want a successive options and obligations.
The purchase price of interests to be purchased under a buy-sell agreement must be set forth in the agreement. Should be fixed or determinable under the terms of the agreement.
- Fixed Purchase Price. Purchase price for shares under the buy-sell agreement may be specified in the agreement. May include provisions for periodic adjustments to ensure price reflects current value.
- Determinable Purchase Price. A mechanism may be included in the buy-sell agreement providing a means of determining a purchase price. The agreement should describe in detail this mechanism. May be formula based on: book value, book value with adjustments, or capitalized earnings.
Terms of Payment
The terms of payment for shares purchased under a buy-sell agreement should be specified in the agreement. These payment terms may include:
- Time of closing of the sale and the obligations of the parties to the closing
- Amount of any down payment
- Amount and periodicity of installed payments
- Interest rate on the unpaid balance of the purchase price
- Remedies for default if the purchase price is not paid in accordance with the terms of the agreement
- Right to prepay installments
- Security for obligation to pay the purchase price
- Delivery and enforcement of shares
- Transfer of Title
Termination of Agreement
Events Causing Termination
How an agreement will be terminated. May include: (1) Written consent of all parties to the agreement; (2) termination of company; or (3) a shareholder becoming the owner of all the interests.
How an amendment to the agreement is to take place. (Ex. Written consent of all parties to the agreement.)
- Life Insurance. If cross-purchase buy-sell agreement, may require the purchase of life insurance on each of the other interest holders.
- Corporate Redemption. If the corporation may be the purchaser of shares under the agreement, the purchase may require authorization of shareholder action. If a corporation is unable to make a required purchase, agreement might require that the other shareholders make the purchase.
- Binding Effect. Provision makes the agreement binding on person who acquire an interest in the future, as well as on the parties to the agreement.
- Notice. How notices, required under the agreement, shall be undertaken
- Attorney’s Fees. Provision provides direction on who pays in the event of litigation.
- Governing Law. States the applicable law that will govern the agreement
- Sole Agreement. Agreement is the entire agreement.
- Provides that if a provision is unenforceable or invalid, the remaining provisions shall be unaffected.
Questions You Should Ask
Overarching Consideration Questions
- What are the goals for the company?
- What is the purpose that the buy-sell agreement is meant to serve?
- Limit ownership to existing interest holders by restricting transfer of shares to third parties?
- Limit ownership to individuals who are actively and regularly employed by the corporation?
- Preserving a corporation’s S corporation election by restricting transfers that would cause the election to terminate?
- Who are the key people involved in the ownership and the running of the business? (Ex. If an owner is not greatly involved in the day to day operations, a trigger for disability may not be necessary)
- How should the value of the interest be determined? If there are multiple options, would it be best to:
- Get the highest price possible? or
- Have a slightly lower price to increase likelihood of another owner purchasing it?
- What would be the preferred amount of time for the transfer process? Would it be better to:
- Have a short period to move through the process quickly? or
- Provide a longer time to allow owners to come up with the capital?
- How should disputes be resolved?
- Should owners owning more than a stated percentage of interest be permitted to make an offer to remaining owners to buy all remaining interest?
- Should the remaining members be allowed to purchase that owners interest?
- In the event of refusal, should the company be terminated?
Specific Agreement Consideration Questions
- What should be considered a triggering event that transfers an owner’s interest?
- Voluntary Transfer Considerations.
- What kind of voluntary transfers, if any, will be permitted?
- Disability Transfer Considerations.
- At what point shall a disability invoke the agreement?
- Transfer on Death Considerations.
- May the decedent’s family own the interest?
- Termination of Employment Considerations.
- Should there be a distinction between voluntary and involuntary employment termination?
- Voluntary Transfer Considerations.
- What should happen when a transfer of ownership has triggered? Should there be:
- Mandatory redemption of the interest by other members?
- Mandatory redemption of the interest by the company?
- Option for business or remaining owners to buy the ownership interest?
- Option to require the company to buy the ownership interest?
- Outside third party redemption?
- Should spouse or children become owners?
- If ownership interest is to remain with current owners, how shall a mandatory purchase of the interest be financed?
- Should Insurance be required?
- If ownership interest can be transferred to a third party, should there be any restrictions on who may hold an interest?
- Should current owners have a right of first refusal?
- Will the transferee have to abide by this agreement?
- Should interest rates be set?
- How long should the buyout period be?
- Should the agreement apply to after-acquired interests?
- What will happen to compensation or non-compete agreements in the event that a business owner departs?
- Should it matter if the departure is involuntary versus voluntary?
- What will be used to determine the actual value of the business? Is a formula outlined in the agreement or does it require the interference of an outside party?