Buy-sell Arrangements
Buy-sell arrangements are agreements between owners of a business that allow the owners to control who gets the ownership interest when an owner leaves. For corporations, the buy-sell allows shareholders to control the stock outstanding by restricting its transfer. (Transfer restrictions are placed in red on the stock certificate.)
I use the term “arrangements” rather than “agreements” to indicate that buy-sell provisions can be within a company governing document, such as an LLC Operating Agreement, or it can be a stand-alone Shareholders’ Agreement for corporate entities. Regardless, of the house where these provisions live, they pretty much look the same, and are agreements between the owners of the business.
Picture it: Cassidy, Brenda, Deidre and Akeem own an LLC. Each is instrumental to the success of the business as they have a different knowledge base. They would not like to bring in another owner – ever. Deidre unexpectedly dies and their LLC ownership interest passes to their spouse. Now what? Cassidy, Brenda and Akeem are stuck with Deidre’s spouse as an owner and that is not what they want. What if Deidre’s spouse does not want to own a part of the LLC and would rather be bought out? How does this occur? When does it occur? Who ensures a fair buy-out price? What if Deidre’s spouse does want to be an active owner but Cassidy, Brenda and Akeem do not want that?
This small hypo highlights one reason why owners should have a buy-sell arrangement set up from the beginning. Boiling this down, the main reasons that business owners enter into buy-sell arrangements are to:
- Create liquidity for an owner who departs due to certain triggering events
- Create liquidity for the family of a deceased owner (so that they are not stuck with an illiquid ownership interest)
- Provide a valuation method for a departing owner’s interest
- Establish a value for the business for federal estate/gift tax purposes
- Facilitate a smooth transition of management and control for the remaining owners
- Keep an ownership interest away from undesirable owners
Attorneys need to be vigilant when it comes to advising clients of the importance of setting up a buy-sell arrangement when the company is first organized. Often clients do not see the immediacy and would rather put these sorts of things off so they can conserve time and money for more immediate needs. Often, I would tell clients that LLC Operating Agreements and the buy-sell provisions are important to avoid fighting later. Why would the client want to spend time building a business only to have the lack of an agreement cause it to crumble later?
Buy-sell arrangements may be amended from time to time. 💡 Think about what kind of scenarios will require an amendment.
Triggering Events
Certain events trigger the use of the buy-sell provisions. The events that trigger the use of the buy-sell provisions are outlined within the document. 💡 How many different triggering events do you see in the