BUY-SELL MECHANISM in a SHAREHOLDERS AGREEMENT

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There are many intriguing clauses that can be found in unanimous shareholders agreements, especially when you are lawyer that has been looking at shareholders' agreements for over 25 years, and have seen the inclusion (and exclusion) of contractual provisions such as the particular buy-sell mechanimss that are drafted into those agreements. The buy-sell mechanism is a critical aspect of a shareholders' agreement, particularly for private corporations with multiple owners, as it establishes a clear plan for the transfer of a shareholder's ownership interest in the business if a specific event occurs.

Key Purposes of a Buy-Sell Mechanism

• Business Continuity: It ensures the business can continue operating smoothly without disruption if a shareholder departs.

• Liquidity for Illiquid Shares: Shares in a private company are not easily sold on a public market. The buy-sell mechanism creates a pre-determined market and process for a departing shareholder to sell their stake.

• Protection for Remaining Shareholders: It prevents an unwanted outsider (like a deceased shareholder's heir or a competitor) from becoming a business partner.

• Fair Valuation: It establishes a method for determining the value of the shares, avoiding potentially costly and emotional disputes over price.

• Financial Assurance: When properly funded (often through life insurance), it ensures that the money is available to purchase the shares, relieving the remaining shareholders or the company from having to find a large sum of cash on short notice.

Common Triggering Events

A buy-sell mechanism is activated by certain "triggering events." These typically include:

• Death or Disability: The most common triggers, which are often funded by life insurance.

• Retirement: A planned exit strategy for an owner.

• Divorce or Marital Breakdown: Prevents a shareholder's ex-spouse from gaining a stake in the business.

• Bankruptcy or Insolvency: Protects the company from a shareholder's financial troubles.

• Termination of Employment: If a shareholder is also an employee, their departure from the company can trigger a sale of their shares.

• Disputes: A "shotgun clause" is a specific type of buy-sell provision used to resolve an irreconcilable dispute between shareholders.

Types of Buy-Sell Structures

There are two primary structures for a buy-sell mechanism, although lawyers also develop hybrid arrangements that are structured oftentimes to address particular aspects of the existing business relationship:

• Cross-Purchase Arrangement:

  • How it works: The remaining shareholders personally agree to buy the shares of the departing shareholder.

  • Best for: Businesses with a small number of shareholders (e.g., two or three), as it can become complex with more owners.

  • Funding: Each shareholder typically takes out a life insurance policy on the other shareholders, with themselves as the beneficiary. The proceeds are then used to buy the shares from the deceased's estate.

• Entity-Purchase (or Redemption) Arrangement:

  • How it works: The corporation itself agrees to buy back ("redeem") the shares of the departing shareholder.

  • Best for: Businesses with a larger number of shareholders.

  • Funding: The corporation may look to take out life insurance policies on each shareholder, with the corporation itself as the beneficiary. The corporation then uses the proceeds to buy back the shares.

• Hybrid Arrangement:

  • A combination of the cross-purchase and entity-purchase models.

  • Typically, the departing shareholder first offers their shares to the company. If the company declines or cannot purchase the shares, the offer is then made to the remaining shareholders.

A buy-sell mechanism is a proactive contractual measure that addresses potential future problems, given that the corporate business legislation and the courts are not a quick and effective means for dealing with these important corporate matters, especially where these scenarios can be time-sensitive and do not benefit from costly and protracted court litigation. By having these contractual provisions in a legally-binding unanimous shareholders' agreement, shareholders can ensure the long-term stability and success of their business, better protecting their interests and those of their families

For knowledgeable and experienced legal representation in negotiating, drafting and reviewing unanimous shareholders agreements, and other essential business contracts to the advancement of your commercial endeavors, contact our law firm by email at Chris@NeufeldLegal.com or by telephone at 403-400-4092 / 905-616-8864.

 

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