Key Buy-Sell Issues for Rapid Expansion
Andrew J. Sherman, Partner, Dickstein Shapiro Morin and Oshinsky LLP
In the early days of a business, many entrepreneurs are so excited about getting the company started with their friends or former coworkers that the kind of details typically addressed in a buy-sell agreement are often over looked, ignored, or just too much of a “downer” to discuss. Indeed, discussing a buy-sell agreement is about as popular a topic as is a prenuptial to a couple deep in the throes of wedding planning, but it is an absolute must in order to ensure the sustainability of any organization.
For rapidly-growing companies, a buy-sell agreement that properly anticipates all of the challenges and dynamics of rapid expansion is a must. To have no agreement in place or even just a basic agreement that has become outdated is a big strategic error and needs to be corrected as soon as possible. Most rapid growth companies fall into one of the following four categories when it comes to these agreements:
If you are in category four above, give yourself a gold star, but keep reading just in case. If you are in category three, your basic buy-sell agreements have probably been superseded, replaced, or influenced by a set of venture capital financing documents that dictate some of the critical issues addressed below. If you are in Category one or two, you had better sit up straight in your chair and pay attention.
What are the issues that every effective buy-sell agreement needs to address?
Relationships are fluid. People change. Hires change. Circumstances change. Market conditions change. Some original cofounders become obsolete. Others become bored. Still others want to pursue other projects. The buy-sell agreement must anticipate these issues and be amended from time to time as circumstances dictate or as new shareholders are added and others depart.
Key issues include:
- What restrictions will we put in place on the transfer of shares? Will the shares be subject to rights of first refusal?
- Has the buy-sell agreement been funded by an insurance policy? Who gets what, and how and when will they get it?
- Are the employment agreements, stock option plans, etc. in alignment with the terms of the buy-sell agreement?
- Is the buy-sell agreement in alignment with the cofounder’s individual will, trusts, and other estate planning documents?
- Do we have a plan or agreement in place that determines (or controls) the ownership of the shares upon death? How will things be different in case of disability or retirement?
- How will these issues be dealt with in case of dispute that leads to a cofounder’s departure from the company, such as a breach of a non-compete clause, embezzlement, or failure to perform key responsibilities?
- What formula or periodic valuation technique will we use to determine the fair value of these shares upon redemption?
- How and when will the proceeds be paid?
- If all of the cofounders are roughly the same age, and the agreement provides for mandatory redemption upon death, who will eventually assume control of the business? If it is the last surviving cofounder (and then his or her estate), have you unintentionally created a “survival of the fittest” policy?
- If the agreement (or lack of an agreement) allows for shares of each cofounder to be passed on to their spouse or heirs, can such individuals get along on a long-term basis? Should ownership be separate from control?
It’s no doubt that it is difficult to talk about these kinds of issues when new business partners come together, but time spent now ensuring that all partners’ interests are met can ensure a business continues as partners desire should something happen that changes the partnership dynamic.
Editor’s Note: The information in this article is provided for educational and informational purposes only. This information does not provide legal or other professional advice and is not the substitute for the advice of an attorney. If you require legal advice, you should seek the services of an attorney familiar with your specific legal situation and the laws of your state.
© 2006 Andrew J. Sherman. All rights reserved.