Family businesses may be dispute free for many years or last for the life of the business without any internal disruptions, but sometimes destabilization can occur from within the family. A shareholder agreement, of which an important component is a buy-sell agreement, can help to prevent most potential concerns that could arise from within the family business. This article explores the value of such agreements that every family business should consider having.
What are the sources of threat to an established family business?
There are several potential threats that can destabilize even a well run family business. These can occur when an individual family member or a faction within the family makes an attempt to dispose of their share of the business. The result can be severe financial consequences for the business, negative effects on the relationships between family members and public embarrassment for the family. Common reasons for wanting to sell a share of the family business include:
- Donating shares to a charity or non-profit organization;
- Personal financial needs unrelated to the business;
- Need to establish or improve an estate plan;
- Disagreement about the trajectory or business model of the family business;
- Deliberate attempt to sabotage the business due to feuding within the family.
A shareholder agreement, which acts a s a sort of insurance policy, set up preferably at the establishment of the business, can prevent or minimize the negative fall-out from any attempt to sell off part of the business. The shareholder agreement, of which an essential component is the buy-sell agreement, is a legally enforceable contract that can be adjusted to suit the individual family business model.
What the shareholder agreement can provide
A shareholder agreement can help to ensure the following:
- Provides rules concerning the sale, transfer and succession of shares in the family business;
- Determines how decisions about how the business is run are made;
- Provides a process for determining the value of individual shares in the business if the business is sold;
- Provides a course of action if any of the shareholders die, become incapacitated or behave inappropriately as far as the business is concerned.
Family businesses that are yet to formulate an appropriate shareholder and buy-sell agreement should do so before it is too late with the help of an attorney. Even family businesses that already have some sort of agreement in place should review its provisions from time to time as the business develops in time to ensure that the agreement continues to provide protection against the negative effects of destabilization within the business.
What is a buy-sell agreement?
The buy-sell agreement is one of the most important components of a shareholder agreement. The buy-sell agreement determines the rights and responsibilities or obligations of each shareholder within the family business in the event of an important change in the personal circumstances of that shareholder. Typical such events that should be covered by the buy-sell agreement include:
- marriage or divorce of the family shareholder;
- retirement or death;
- incapacity due to medical misfortune;
- malpractice.
The buy-sell agreement ensures that there is a measured transition of ownership of shares in place of allowing shareholders to freely dispose of their share of the business whenever they want. A well set out buy-sell agreement should provide answers to the following questions:
- what sort of events might cause an obligation to buy or sell shares of the business;
- how shares will be valued;
- who in the family business has the right to own shares;
- calculation of the purchase price of shares involved in any transaction;
- terms of any transaction, including how it should be funded.
Good reasons for having an effective buy-sell agreement in place
One of the reasons for the effectiveness of many family businesses as a business model is that they tend to be inherently more long lasting. Long term stability is favored as an aspect of a business’s competitive advantage over other models of ownership. An effective buy-sell agreement made between the shareholders of the family business smoothes out the potential hiccoughs that could arise within the business, helping to ensure the desirable qualities of long term stability.
A buy-sell agreement can provide significant advantages for the running of any family business by:
- ensuring that only descendants of the family are able to purchase or own shares in the business;
- creating a market for the sale of shares within the family by establishing the conditions by which shares can be sold or transferred;
- determining the “triggers” that could pre-empt the sale, purchase or transfer of shares within the business; typical triggers include death, incapacity, divorce and misconduct;
- providing a method with which shares can be valued at the time of a sale or transfer, such as fixed-price agreements which set a fixed dollar amount on future share sales, or formula agreements which provide a formula for determing how shares should be valued.
Legal help for family businesses needing to establish or revise a buy-sell agreement
As shareholder and/or buy-sell agreements are legally enforceable contracts between the owners of shares in a family business, it is important to have such an agreement reviewed and created by an attorney with professional family business law experience.For more information, visit our website or contact us for a free initial legal consultation today.