The global pandemic has had business owners rethinking their processes, procedures, and plans. While most owners are focused on day-to-day operational matters to weather this current economic environment, many are also strategizing and revisiting corporate documents to ensure they reflect the new reality. One of the more important documents – which may have been drafted five, ten, or even twenty years ago – is the shareholder (or buy-sell) agreement.
The purpose of the shareholder agreement is to outline the rights, obligations, restrictions, and responsibilities of shareholders to one another. It should include a number of key provisions in order to:
- Dictate terms for shareholder transactions
- Protect the company from an unintended liquidity event
- Prevent shareholder disputes and potential litigation
- Direct funding mechanisms
- Protect each shareholder’s family/estate
- Ensure fairness to the shareholders and company
Although the agreement is a legal document, it should be written in plain English. Unfortunately for many companies, after it is prepared by an attorney and executed by the shareholders, it is put into a filing cabinet and not revisited. This, we believe, is a big mistake which could result in serious consequences (financial, operational, and emotional) to both the business and its owners in the future.
While it is important to engage an attorney to draft the legal document, the key provisions of the agreement should be developed by a businessperson, in conjunction with the shareholders, to ensure that critical factors are considered and incorporated. We’ve seen too many agreements that appear legally structured, but are written in a manner that are difficult and/or costly to administer, omit key provisions that may impact the shareholders, and don’t achieve the intentions of the owners.
Here are vital questions to address when determining what key design elements to include in the shareholder agreement:
- What are the triggering events (death, disability, retirement, sale, etc.) for shareholder transactions?
- What type of transaction is it? Will the company or the other shareholders be repurchasing the shares?
- How is the value/price determined? We are proponents for including a valuation formula or other mechanism to determine the transaction value. Too often, we see agreements that indicate a valuation of the business will be performed to determine share value. This results in unnecessary costs and is often subject to dispute.
- How will the transaction be funded?
- Are there restrictions on transfer?
- Are there specific requirements to be a shareholder? Is employment with the company required?
- Will there be employment agreements or non-compete agreements?
- Are there tail or trailer provisions?
If your shareholder agreement is missing any of these key provisions, is accumulating dust in the back of your filing cabinet, or you would like a professional to review it, please do not hesitate to contact us. You, your family, and the business will be happy that you did.
Mark G. Metzler is a Director with Kreischer Miller and a specialist for the Center for Private Company Excellence. Contact him at Email.
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