As we have previously noted, if businesses are analogous to marriages, then the start-up of businesses begins with the “honeymoon” stage in which the business partners believe that they have similar visions of the company’s rosy future. Things change.
The list of “things that change” is long including the death, retirement or disability of your business partner; you or your business partner wanting to sell your interest in the company; or one of you wanting to add another business partner. What do you do then?
These situations can be much more orderly and much less stressful if, at the formation of your entity, your experienced business attorney helps you draft “buy-sell” provisions into your shareholder agreement (for corporations) or operating agreement (for limited liability companies). With properly drawn buy-sell provisions, you can better ensure the continuing viability of your company and maintain control over who your fellow shareholders or members may be. Using the marriage analogy, these agreements are similar to “pre-nuptial agreements.”
Essentially, a buy-sell provision places restrictions upon the sale of either your stock (in a corporation) or your membership interest (in your limited liability company). Let’s assume you have a limited liability company (“LLC”). Your business partner, a 50% member of your LLC wants to sell his interest in the company. If you have a buy-sell provision in your operating agreement, before he can sell his membership interest he must a) have a bona fide offer; and b) offer to sell to the LLC or to his fellow LLC members at the same price. If you decide to purchase that interest, you can do so to avoid becoming a business partner with somebody you did not choose. If you decline to purchase that interest, the prospective purchaser must close within the time period specified in your operating agreement (it can be any amount of time, but many agreements specify closing must occur within thirty days). The time period is important because a failure to close within that time period can restart the process.
These agreements are contracts in which the parties can reasonably negotiate any and all terms. Furthermore, Virginia courts will enforce these buy-sell provisions in shareholder agreements or operating agreements as any contract. In the Virginia case of Hamlet v. Hayes, the Virginia Supreme Court reviewed the terms of a shareholder agreement. A third-party offered to purchase the shareholder’s shares. Pursuant to the buy-sell provisions, the shareholder had to offer those shares to the company, and if the company declined to purchase the shares, the other shareholders could purchase the shares. Although the company declined the option, the other shareholders accepted the offer. However, the selling shareholder refused to sell. The Court enforced those provisions holding that the shareholder agreement was a binding contract enforceable by the parties. Consequently, the selling shareholder would have to sell his shares pursuant to the terms of the contract and the shareholder agreement.
Few details are more important when forming your new company with business partners than buy-sell provisions. This basic primer introduces the concept and in later posts we will discuss many of the specific topics within buy-sell agreements.
Tarley Robinson, PLC, Attorneys and Counsellors at Law
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