One of the things we commonly do when entering into a new client relationship is review the company’s shareholders’ agreement (sometimes referred to as a buy-sell agreement). When doing so, we often discover that the agreement is out-of-date or does not reflect the shareholders’ current thinking.
For private companies, a shareholders’ agreement dictates the terms and conditions for how ownership is exchanged, sold, and transferred. In many cases, these agreements are viewed as arcane legal agreements that sit in a drawer because they have no present bearing on what happens in the business. It is true that these agreements don’t come into play often because there are not many shareholder transactions in a private company. However, when transactions do occur, they can have a dramatic effect on the future of the company and its shareholders.
These agreements are not only important from a transactional standpoint, but they must also be in sync with the long-range plan of the shareholders or family that owns the business. For instance, we have seen cases where a family business plans to continue its legacy through succeeding generations. However, the shareholders’ agreement contains provisions that require buying or selling shares upon certain triggering events, making it counter to the family’s legacy plan.
Below are some key questions to consider as you review your company’s shareholders’ agreement:
- Does your agreement address all triggering events that would cause a share transaction, including death, disability, retirement, separation from employment, or voluntary sale of shares?
- Does it have buy-sell provisions that vary based on the type of triggering event, so that the company is protected? This could mean creating different payout terms for each type of triggering event.
- Is the share value easily determined or is it a complex process involving many outside parties? If it is not straightforward, it could lead to significant costs and disagreements among the shareholders.
- Is the agreement consistent with the family’s policy about who can own shares? For instance, can someone who doesn’t work in the business own shares or is company employment required to be a shareholder?
- Is there sufficient life insurance in place to protect the company and the shareholders’ families in the event of a shareholder’s death?
- Is it clear whether share transactions are structured as redemptions by the company or cross-purchase transactions among shareholders? Are the life insurance owner, insured, and beneficiary designations consistent with the type of transaction structure?
- Are the agreement’s provisions consistent with the shareholders’ long-term plans for the company’s ownership and transition?
These are just a handful of high level questions based on the common issues and inconsistencies we see in the agreements we review and restructure. However, there are many more important details to address with these agreements. We recommend making a habit of reviewing your company’s agreement annually to make sure it is consistent with the long-range goals for your company and its shareholders.
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