Shareholder Buyout Agreements
Buyout agreements, also referred to as a buy-sell agreements, are used in many types of business structures, including corporations, limited liability companies, S corporations, limited partnerships, and general partnerships. In a small, privately held company, a buyout agreement can limit or restrict a shareholder's ability to sell or transfer shares when leaving a company.
Reasons for Buyout Agreements
A buyout agreement does not define the terms of the sale or purchase of a company. A buyout agreement is a contract between the shareholders of a company. The agreement determines whether a company must buyout a departing shareholder or whether a company has the right to buyout a shareholder when a certain event, such as a shareholder's death, occurs. A buyout agreement protects shareholders from complications that arise when a shareholder decides to leave a company. A buyout agreement determines:
- Who can buy a shareholder's stock
- Whether the company must buyout the shareholder
- How to measure the value of a shareholder's interest
- Payment terms for a buyout
A buyout agreement ensures that a company can prohibit an unwanted buyer from gaining an interest in the company and determines how a shareholder can dispose of an ownership interest in a company. Shareholders of a corporation usually include buyout agreements in the articles of incorporation, the by-laws, or in a separate written agreement.
Buyouts when Certain Events Occur
Buyout agreements determine what events will initiate a buyout. Most agreements identify the following events:
- Personal bankruptcy: Buyout agreements usually allow a company to acquire the interest of a bankrupt shareholder.
- Death: If the buyout agreement requires, the decedent's family may be required to sell the inherited share back to the company.
- Retirement: When a shareholder is no longer active in the business, many agreements allow for the acquisition of a retiree's interest when the shareholder reaches a certain age.
- Divorce: An agreement may require the ex-spouse of a shareholder to sell the acquired ownership interest back to the company.
- Disability or incapacitation: A buyout agreement can compel the sale of a shareholder's interest after the determination of a permanent disability.
- Termination of employment: Some buyout agreements force a terminated employee to sell their interest back to the company. This provision is intended to prevent the former employee's continued access to private company information.
How to Fund a Buyout
To buyout a shareholder, a company must be able to pay for the value of the ownership interest. A company can fund the purchase of a shareholder's interest by using:
- The assets of the business: A buyout agreement may stipulate that the company can pay over time with the income earned from the business. For example, a payment plan may allow a company to put 20 percent down and pay the remaining balance in installments over five or ten years.
- The proceeds of an insurance policy: Many companies purchase life insurance policies, and sometimes disability insurance policies, for each shareholder. If the shareholder dies or becomes permanently disabled, the company can use the proceeds of the policy to buy out the deceased shareholder's interest.