Assume that you hold 50% of the shares in a successful corporation. The other 50% of the corporation’s shares are held by your trusted friend and colleague of twenty years, Honest Goodguy. Honest Goodguy and you have always agreed upon the operation of the corporation’s business, and the internal governance of the corporation. In short, life and business has been, and is, good with Honest Goodguy.
One day you receive unexpected news that Honest Goodguy suffered a massive heart attack, and sadly, did not survive. Honest Goodguy, the ever-prepared fellow he was, had prepared an estate plan to cover situations just like these. As part of his estate plan, Honest Goodguy’s nephew, John Q. Dirtbag received all shares held by Honest Goodguy in the corporation. Meet your new co-shareholder, John Q. Dirtbag.
How could this have happened? It happened partially because you allowed it to happen by not having a buy-sell agreement in place between yourself and Honest Goodguy. In fact, if drafted correctly, the buy-sell agreement could have prevented Honest Goodguy from selling or transferring his shares before or after his untimely death. Depending on the provisions of the buy-sell agreement, either a transfer or sale of the shares could have been subject to a right of first refusal held by you as shareholder and party to the buy-sell agreement. In other words, you would have a right to purchase the shares before either a transfer or sale of the shares, and in this way, you have a measure of control over who may own the shares.
Buy-sell agreements are contracts by which interest holders in entities may seek to maintain control over the ownership and management of their business by restricting or compelling the transfer of the ownership interests. In this case, a buy-sell agreement would have placed restrictions on the transfer of the corporation’s shares.
A buy-sell agreement can be mandatory or discretionary repurchase of ownership interests upon the occurrence of certain events which are expressly provided in the buy-sell agreement.
The main elements of a buy-sell agreement are the:
- Events which trigger the buy-sell agreement;
- Mandatory or discretionary nature of the interest owners rights in relation to the triggering events;
- Rights of first refusal, if any;
- Identity of the persons or entities which may purchase the ownership interests; and
- Purchase price and terms associated with the transfer of ownership interests.
This blog post is the first in a series of posts regarding buy-sell agreements. In the next blog post, I will discuss triggering events in buy-sell agreements in more detail.
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