When individual entrepreneurs join forces to start a new business, their excitement level is usually very high. Sometimes, the excitement can block from view the need to prepare documents that may be crucial to the company’s future. One of these agreements is a cross-purchase or buy-sell agreement.
What does a buy-sell agreement do?
Simply put, a buy-sell agreement specifies the terms and conditions under which a shareholder can leave the company by having the company or the other shareholders purchase his stock. Despite this simple explanation, the mechanics of a buy-sell agreement can be quite complex
The “trigger clause”
Perhaps the most important provision in any buy-sell agreement is the section (or sections) that specifies the events that allow one shareholder or the company to enforce the mandatory purchase or sale provisions in the contract. For example, shareholder deadlock is a common reason for one or more shareholders to decide to leave the company (or buy out the interest of the shareholder whose disagreement has brought deadlock to the boardroom).
A buy-sell agreement can also specify the situations in which a new shareholder can join the company. Other reasons for allowing the company or a shareholder to invoke the mandatory purchase or sale provisions is the divorce or bankruptcy of a shareholder. These situations may give another party—the ex-spouse or the bankruptcy trustee—power over a significant share of the company’s stock.
Mechanics of payment
A properly drafted buy-sell agreement will also specify the mechanics of payment. Most agreements provide for installment payments to be made to the selling shareholder. These installment payments are usually secured by a lien on the assets of the party making payments.
Determining the price
Many buy-sell agreements are signed and then put in a drawer somewhere. If the agreement is invoked, the price—or means of determining the price—for the interest of the selling shareholder may have become unfair over time. If the unfairness is extreme, the disadvantaged shareholder may be tempted to commence litigation to enforce the agreement. A far better scheme is to provide that the value of the company’s equity will be determined by an impartial appraisal. The method of choosing the appraisers can be difficult, but many models for such choices are available.
Seeking legal advice
A buy-sell agreement can be signed at any time. Anyone who believes that a buy-sell agreement should be considered by the company’s founders or managers may wish to consult with an experienced business attorney for advice on the various forms such an agreement can take.