Writing Effective and Comprehensive Buy-Sell Agreements

Identify potential problem areas before entering a buy-sell agreement.

Any transaction involving the purchase and sale of a corporation contains areas of potential and costly conflicts. The following checklist will enable purchasing and selling parties to deal with potential problem areas at the time the transaction is entered into so as to avoid possible future litigation.

Checklist for Buy-Sell Agreements

1. Should the buy-sell agreement apply to just current shareholders or to all new shareholders during the life of the new or existing corporation?

2. There should be a statement in the buy-sell agreement to the effect that it supersedes all other existing agreements to redeem stock or purchase stock executed by the shareholders.

3. Will the death of a shareholder in the corporation result in an automatic buy-out of his interest, or will the next of kin be allowed to become a shareholder in the corporation?

4. Will all of the death buy-out amount be funded by insurance, or just part of it? In the event of a death buy-out, will all the proceeds from the policy be used to redeem the stock of the deceased shareholder.

5. In the event of the death of a shareholder, what will be the disposition of shareholder receivables or payables?

6. What will be the price paid to an employee shareholder who resigns or is fired from the corporation?

7. In case an employee shareholder resigns or is fired from the corporation, will a covenant not to compete be involved, and if so, what will be its geographic area (fifty miles, for example) and for how long will it be in effect (for example, five years, or in conjunction with the installment payments of the buy-out if not paid in cash)?

8. How many days should the corporation have in which to pay off a terminated, disabled, or deceased shareholder?

   OBSERVATION Certain arrangements, called either stock redemption or cross-purchase agreements, assure the further continuance of the corporation. These agreements may also give the corporation or shareholders the right of first refusal should the stock become available due to the death of a shareholder or because a shareholder wishes to sell her stock.

   EXAMPLE Mike Smith and Jim Kelleher are equal shareholders in SMK Consulting, Inc. By prior written agreement, if either individual dies, retires, or becomes totally disabled, the other shareholder is required to purchase the shares, thus becoming the sole shareholder. This is an example of a cross- purchase agreement.

9. Disability buy-out is a sensitive subject for employee shareholders to discuss. However, a disabled corporate employee cannot be carried for very long in a small business. Most businesses use a disability buy-out period of between three and six months. In other words, if one of the employee shareholders becomes totally disabled for a period of three months, on the first day of the fourth month, the corporate employee's stock is automatically sold back to the corporation at a disability buy-out price.

10. The corporation needs to discuss the possibility of one of the shareholders finding a non related third party to buy his stock. Does the corporation want shareholders to have the right to sell on the open market to any third party or only have the right of first refusal? Or does the corporation want to restrict rights and only allow the shareholders to sell back to the corporation itself. There is quite a danger in allowing for unrelated third parties to make offers on stock of closely held corporations. Obviously a competitor could make an offer, making it hard to tell if it was a bona fide offer or just a ploy to drive the stock price up so that the remaining shareholders would have to pay a higher price to repurchase the stock.

11. All shareholders in the corporation who sign buy-sell agreements should also have their spouses, if any, sign the agreement as well. It is best to do this at the attorney's office and have the signatures witnessed or notarized. This prevents later problems in the event of a marital dissolution.

12. Shareholders of a corporation must decide whether or not the corporation will guarantee obligations to a retiring or deceased shareholder. The obligations should be personally guaranteed by the remaining shareholders when a shareholder dies or retires because the corporation could eventually become insolvent. Since one of the most important functions of a corporation is to shield the shareholders from personal liability, the personal guarantee, in writing, of every shareholder would provide the best protection against pending obligations.