Buy-Sell Agreements Can Prevent Shareholder Lawsuits.
by H. Joel Newman, Business Litigation Attorney
Owners of closely held corporations and limited liability companies frequently have no way to cash out because there is no ready market for their fractional shares. If a partner wants to liquidate, she may not have an available avenue. A buy-sell agreement can be incorporated in the Company’s operating agreement, or it can be a stand-alone document.
A well drafted buy-sell agreement can create a market for the shares, can enhance predictability, and can provide for continuity of the ownership/management group. A buy-sell agreement can also help to avoid frivolous shareholder or member lawsuits, which often occur when an owner is otherwise unable to liquidate her shares. We have seen many lawsuits over the years which could have been prevented with appropriate buy-sell documents.
Form documents should be avoided. It is important that buy-sell agreements be drafted by knowledgeable attorneys, because there are myriad circumstances to take into account. To list just a few:
- Triggering events:
- • Termination of employment
- • Voluntary;
- • For cause;
- • Without cause;
- • Disability/death;
- • Change of Control;
- • Any other events significant to the business and/or to which the owners agree.
- • Termination of employment
- Puts and calls
- • When must the owner sell?
- • When must the company or other shareholders buy?
- Should there be restrictions on who may become an owner?
- • The agreement could require redemption by the company;
- • The agreement could require sales to insiders only;
- • The agreement could require that sales to outsiders are subject to approval of the other owners.
- Source of buy-out funding must be available.
- • Life insurance and disability insurance on substantial owners can fund buy-outs upon their death or disability;
- • The Company might fund a redemption;
- • Private funding for purchasing owners
- Price setting formula or mechanism. This is critical. It is vitally important that the formula be fair. Specific valuation methods might be entirely appropriate for one business and wholly inappropriate for another. It is also important that the formula employed provide as much certainty as practical. Pricing can be set by any number of means:
- • An appropriate multiple of EBITDA for one year or multiple years;
- • Book value;
- • Comparable sales. This data is difficult to obtain for closely held companies and leaves much room for argument;
- • Appraisal;
- • Periodic agreements among owners as to value;
- • Right of first refusal. The company, and/or insiders would have the right to match any outside offer.
- • An agreement can call for a look-back adjustment for a fixed time period.
- • The agreement can set different pricing or discounts based on the specific circumstances. For example, a termination for cause might trigger a buy-out at a discount where death or disability might not.
- Terms of payment and security for payment should be set out in detail.
H. Joel Newman is an attorney specializing in business litigation, commercial litigation and shareholder disputes. Practicing in Oakland County Michigan, Wayne County Michigan and Macomb County Michigan.