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Using a Buy-Sell Agreement to Avoid Shareholder Disputes

Nov. 18, 2020

When two or more individuals own a business that is or may be on the brink of success, they may decide to choose a formal entity for the business. If shares are split equally between the shareholders, say 50/50 or 20/20/20/20/20, the potential for corporate deadlock is obvious. If share are not split equally, say 60/40, 75/25 or 50/25/25, the potential for shareholder oppression is likewise obvious.

Regardless of the percentage by which the shares are allocated, any business with more than one owner can trip over the painful obstacle of an intractable dispute among the shareholders. One of the safest methods for avoiding such disputes is the signing of a buy-sell agreement at the time of incorporation.

The Essence of A Buy-Sell Agreement

In its simplest form, a buy-sell agreement is a contract that gives any shareholder the right to force the corporation or the other shareholders to purchase his interest in the company. Despite the apparent simplicity of this form, drafting a buy-sell can involve a variety of difficult issues that must be resolved to ensure the enforceability of the agreement.

Triggering the buyout. Most buy-sell agreements either provide specific conditions which permit one shareholder to exercise his rights under the agreement. Another method is to allow one shareholder to trigger the buy-out by delivering a written offer to purchase or demand to sell, whichever may be appropriate.

Determining the Value of The Entity

One of the fundamental concepts of a buy-sell agreement is the assumption that the shares being purchased will be valued fairly. The determination of fair value, however, is not always straightforward. The buy-sell agreement can simply assign a value expressed in dollars per share. The buying shareholder is required to pay this price, and the selling shareholder is required to accept this price.

Unfortunately, the value fixed in the buy-sell agreement may not always reflect reality. In such cases, the shares can be valued according to any change in the company’s net worth. A third method is the appointment of an appraiser to fix a fair value. The buy-sell agreement will usually fix the method of choosing the appraiser. A well-drafted buy-sell should specify a valuation date.

The Lawyer’s Role in Drafting the Agreement

As this brief summary implies, drafting a buy-sell agreement is not a simple task. The parties to the agreement may wish to have their own attorneys review the document before they sign it. In any event, the buy-sell agreement and the demand for sale or purchase should be drafted by an experienced business lawyer.