Shareholder Buyout Agreements: Plan Ahead for Changes in Corporate Ownership
Buyout, or buy-sell, agreements control changes in the ownership of a corporation - they act as a premarital agreement between shareholders and cover what happens when an owner wants out.
Buyout, or buy-sell, agreements are often overlooked by shareholders who have diligently filed their articles of incorporation and adopted their corporate bylaws. Without a buyout agreement, however, if a shareholder wants to leave the company and be bought out, there’s no contract that says whether the remaining shareholders or the corporation must buy him out, or for how much.
By creating a buyout agreement, the owners of a small privately held corporation can be prepared when a shareholder wants to be bought out, or worse, dies, goes bankrupt, or gets divorced.
What Are Buyout, or Buy-Sell, Agreements?
Contrary to popular belief, buy-sell agreements don’t have anything to do with buying and selling companies. Instead, they control when and how shares in a corporation can be bought and sold. Buy-sell agreements are also sometimes called shareholders agreements or stock agreements. Because of this confusion over terminology, we will use the term buyout agreement from now on.
Typically, a buyout agreement controls the following decisions:
- Whether a departing shareholder must be bought out
- Who can buy a departing shareholder’s stock (this may include outsiders or be limited to other shareholders)
- What price will be paid for a shareholder’s interest in the corporation, and
- What other events will trigger a buyout.
It may help to think of a buyout agreement as a sort of “premarital agreement” between co-owners.
What Events Should Be Covered in a Buyout Agreement?
Typically, the events that trigger the buyout of a shareholder’s interest are:
- The retirement or resignation of a shareholder
- An attractive offer from an outsider to purchase a shareholder’s interest in the corporation
- A divorce settlement in which a shareholder’s ex-spouse stands to receive all or part of a shareholder’s stock of the corporation
- The foreclosure of a debt secured by a shareholder’s stock
- The personal bankruptcy of a shareholder, or
- The disability, death or incapacity of a shareholder.
Why You Need a Buyout Agreement
It’s a mistake to ignore the fact that sooner or later your business will change. The odds are that one of your founding co-owners will want to leave the company (and take his investment with him) before the rest of the shareholders are ready to call it quits.
In addition, a buyout, buy-sell, agreement puts limits on who can buy shares in the corporation. Otherwise, you could be forced to share control of the company with someone you’d rather not run a business with.
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