Shareholder Buyout Agreements--Why You Need One

Shareholder buyout agreements cover what happens when an owner wants out.

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Buyout, or buy-sell, agreements are often overlooked, even by shareholders who have diligently filed their articles of incorporation and adopted their corporate bylaws. But this can be a costly mistake: Without a buyout agreement, if a shareholder wants to leave the company, there's no contract that says whether the remaining shareholders or the corporation must buy him out, or for how much.

By creating a buyout agreement, the owners of a small, privately held corporation can be prepared when a shareholder wants to be bought out, or worse, dies, goes bankrupt, or gets divorced.

What Are Buyout, or Buy-Sell, Agreements?

Contrary to popular belief, buy-sell agreements don't have anything to do with buying and selling companies. Instead, they control when and how shares in a corporation can be bought and sold. Buy-sell agreements are also sometimes called shareholders' agreements or stock agreements. Because of this confusing terminology, we will stick to the term buyout agreement from now on.

Typically, a buyout agreement controls the following decisions:

  • whether a departing shareholder must be bought out
  • who can buy a departing shareholder's stock (this may include outsiders or be limited to other shareholders)
  • what price will be paid for a shareholder's interest in the corporation, and
  • what other events will trigger a buyout.

It may help to think of a buyout agreement as a sort of "prenuptial agreement" between co-owners: It determines what will happen if your corporation's owners decide not to stay together 'til death do them part.

What Events Should Be Covered in a Buyout Agreement?

Typically, the events that trigger the buyout of a shareholder's interest are:

  • the retirement or resignation of a shareholder
  • an attractive offer from an outsider to purchase a shareholder's interest in the corporation
  • a divorce settlement in which a shareholder's ex-spouse stands to receive all or part of a shareholder's stock in the corporation
  • the foreclosure of a debt secured by a shareholder's stock
  • the personal bankruptcy of a shareholder, or
  • the disability, death, or incapacity of a shareholder.

Why You Need a Buyout Agreement

It's a huge mistake to ignore the fact that sooner or later your business will change. Chances are, one of your founding co-owners will eventually want to leave the company (and take his investment with him) before the rest of the shareholders are ready to call it quits.

When one shareholder quits to move to another city or leaves to start another business, without an agreement who decides whether the remaining owners have to buy out the departing shareholder, and for much? If you don't anticipate and plan for circumstances like these, you're risking serious personal and business discord -- perhaps even court battles and the loss of your business.

In addition, a buyout agreement puts limits on who can buy shares in the corporation. Otherwise, you could be forced to share control of the company with someone you'd rather not run a business with.

Creating a Buyout Agreement

To create a buyout agreement, you can use either a self-help resource or see a lawyer -- or both. One good tool is Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by Anthony Mancuso and Bethany Laurence (Nolo). The book contains a disk with a fill-in-the-blanks buyout agreement and guides co-owners through a discussion of their options. Even if you plan on using a lawyer, the book can help you decide on your own time -- not your lawyer's -- what you want to include in your agreement.

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