By Maurice Walch
Many people believe the Shareholders Agreement is a Buy Sell Agreement (BSA) and vice versa. However, a BSA can form part of a Shareholders Agreement or it can be an entirely separate document. As the Shareholders Agreement is built to establish trust necessary to build and operate the company, the BSA is designed to map out an orderly transition of share ownership when a shareholder leaves the company.
It’s hard to conceive of leaving a company just when you are setting it up, however that is actually the best time to discuss the issue. Primarily because everyone is on good terms when starting up a company. By having the discussion at this time, all parties can reflect on what is a fair way to treat the departure of any shareholder, and it may also crystallize their thinking about their personal goals, and how they see their future business activities playing out.
There are only three basic ways a shareholder can leave a company: death, disability, or retirement. A properly structured BSA will provide a road map for the stakeholders to successfully negotiate a smooth transition when these events occur. Whichever the event might be, the BSA must consider the three key elements of the buyout transaction.
1. The triggering event
2. The valuation method for the shares
3. The method of financing the purchase
As mentioned above, there are three possible triggering events. In the event of death, the key question is who is taking over the shares of the deceased? A family member, the surviving partners, or the company? If it’s a family company then a successor family member may be clearly identified, if not, family disharmony becomes a distinct possibility. In a company that has multiple shareholders (family or arms-length), the surviving shareholders may not want to become partners with the deceased’s shareholders spouse or children. How do they prevent that from happening and how does the deceased partner ensure his family receives value for his shares upon his death? The answers to these questions need to be found in the Buy Sell Agreement.
The second possible triggering event is the disability of a shareholder. This is not as clear cut as a shareholder’s death, as disability may be something more nebulous. It may evolve over time with a continual diminishment of a shareholder’s abilities, or it could be a sudden short or long-term disability. To further complicate things, a shareholder could be losing skill sets but refuse to admit it. By continuing to work, the value of their work may be impaired and business may be lost.
The key here is how the shareholders define disability. With a clear-cut definition, there is no disagreement to whether or not a partner is disabled. By identifying the triggering event, a solution can then be arranged.
As for retirement, it may be the classic situation of reaching the age of 65 or it may be simply that the shareholder wants to move on to other challenges. This situation has many of the same challenges as the departure of a shareholder due to death. Is there a successor in place with the abilities to fill the shoes of the retiring party? If so, can they afford to buy it? If no clear successor exists, will the value of the company be diminished? Who will buy the shares, the company or existing shareholders? Again, many questions that are better answered when everyone is healthy and happy.
In all these events, someone has to come up with the cash to redeem the departing shareholder’s position. Before that can happen, a valuation of the company needs to be completed. There are a number of different methods to determine the market value of a company. What is most important in an effective BSA is to determine who is going to determine the value and what is the formula to be used? This creates an environment that allows all shareholders to relax in these stressful situations, and let the process do what they designed it to do.
The final key element is the method for financing the purchase. Each of the triggering events have unique characteristics that lend themselves to different financing options which will be covered in future articles.
The company is an entity unto itself and it needs to make sure it can survive the loss of a shareholder. An effective BSA increases the company’s survival chances immeasurably when a shareholder leaves.
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