Every business with two or more owners, whether it be a C-Corporation, S-Corporation, Limited Liability Company (LLC), or Partnership, should strongly consider having a Buy-Sell Agreement in place.
A buy-sell agreement (also known as shareholder agreement or succession agreement) legally binds the business and its owners to how important future changes will affect the management and control of the business. For example, a buy-sell agreement addresses things like: What will happen if an owner dies or otherwise cannot participate in the business any longer? When can an owner sell his or her stock/shares or membership units? Who can buy an owner’s stock/shares or membership units? What will happen if an owner files for bankruptcy? What happens when an owner divorces their spouse? It is much easier to prepare a buy-sell agreement when none of these events have happened yet. It is important, therefore, to establish the buy-sell agreement early in the business’s life-cycle, before these issues come up and the owners or their heirs or successors begin to argue about how to proceed.
An effective buy-sell agreement may accomplish any combination of the following:
- Make sure that the remaining shareholders will be able to continue ownership and control of the business without interruption
- Prevent the sale of shares that will disturb existing control
- Prevent outsiders from becoming owners and disturbing business operations
- Force out inactive shareholders, members, or partners
- Establish how the “buy-out” price will be determined
The buy-sell agreement may provide that the company will buy out the shares (a so-called “stock redemption”) or that the remaining shareholders can purchase the shares (a so-called “cross-purchase” agreement). The agreement can also provide for a hybrid buy-out where both the company and shareholders have an option to purchase the shares.
The buy-sell agreement may also specify how the “buy-out” will be funded. For example, if a corporation will redeem the shares, accumulated earnings may be used. Insurance is also commonly used to fund buy-outs.
If you have any questions about buy-sell agreements or any other California Business Law issue, do not hesitate to contact a business law attorney.