Why Corporate Planning Is Important: Buy/Sell Clauses
Buy/Sell clauses within an unanimous shareholder agreement(USA)
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There are many events that may necessitate the purchase or sale of shares in your corporation. Even within a small corporation, unavoidable life events may necessitate the transfer of ownership of your corporation or the business of the corporation.
While it’s impossible to predict the future, it is very possible to write buy/sell agreements or buy/sell clauses within your unanimous shareholder agreement (USA). However, it’s a complex process and one that should be handled by a competent lawyer who has extensive experience in both drafting these agreements and defending them in court.
Within this post, I’ll illustrate a few items that may be included within the buy/sell options, however it is best to customize these to fit your specific corporate goals.
Be prepared for common life events
The old saying about two sure things, death and taxes, applies well here. Your buy/sell clause can direct the outcome of the death of a key person or shareholder. These events are especially applicable to small and mid-size corporations and can make estate planning much easier. Likewise the disability or incapacity of a shareholder or key individual may also be addressed – and make sure you define incapacity. Incapacity may include bankruptcy, mental or physical incapacity. You may also want to designate a retirement age and the procedures to end a shareholder’s employment in the corporation.
Unexpected life occurrences, like divorce, death or insolvency of a shareholder can place the corporation into high stress or serious jeopardy, but you can be prepared for these uncertainties by including buy/sell clauses.
Proceedings for winding up or dissolving the corporation and change of control of corporate shareholders are other points you may address.
The shotgun clause
The opposite of a shotgun wedding, in which two people are forced into a relationship, in a USA a “Shotgun Clause” may be used to force somebody out of your corporation. It’s an aggressive clause that should be included, and used, with care
To use a simple example of how a Shotgun Clause may work, let’s imagine a corporation with a value of $1 million with two shareholders – essentially partners working together named Danielle and Jordan. Danielle has been noticing business has been getting slow and she’s concerned about Jordan’s ability to lead the company toward profitability. Motivated by her concerns, Danielle presents an offer to buy Jordan’s share of the business at a significant discount due to the lull in sales. With an offer of $300,000 she has essentially “pulled the trigger” that activates the shotgun clause.
At this moment Jordan is faced with a decision he must make within a short period of time. He is compelled to accept Danielle’s offer of $300,000 and forfeit his shares unless he can reverse the offer. And this is where this clause may literally backfire! Perhaps, while sales were slow, Jordan was meeting with a new client and is just about to close a major deal that Danielle wasn’t aware of. Now he has the opportunity to counter Danielle’s discount offer and push her out of the corporation. In essence, he gains complete control of the company for $300,000.
In theory, a Shotgun Clause should motivate shareholders to put their best efforts into a business or at least be fair in their offer to buy out the other shareholders. However, a shareholder coming into a business who has limited economic resources relative to the other shareholder(s) should be wary of signing an agreement with a Shotgun Clause as it will favour the party who has the greatest capacity for risk. This issue of favouring the more financially stable partner may be mitigated by including requirements to allow payment by instalments or setting a minimum price for which shares may be purchased.
Option to purchase
It’s a good idea to plan ahead for options to purchase a sizeable share of your corporation. You may want to designate shareholders who can match a 3rd party’s offer to purchase, in essence giving insiders the first priority to buy. You should also consider a valuation formula to determine what the corporation is worth and having shareholders update the valuation annually.
Further considerations
Corporations with more than two shareholders require additional contingencies. For example, more than one offer may be presented in a Shotgun or Option to Purchase and it would be prudent to account for that within your legal wording.
Other complications may arise with shareholder financial obligations through shareholder loans, guarantees and other personal obligations. Likewise if a departing shareholder is a director, officer or employee you should be prepared to handle releasing the company from further obligations for severance pay and, conversely, releasing the shareholder from any liabilities to the corporation. Also consider specific non-compete, non-contact and/or non-disclosure/confidentiality clauses that would prevent a departing employee or shareholder from working or investing with a competitor.
Prepare early and profit later
Once you begin working within your corporation it may become increasingly difficult to put these important clauses in place. It certainly is possible to update and amend your Unanimous Shareholders Agreement at any point in a corporation’s lifetime, but it’s always easier to come to an agreement when you’re in the honeymoon phase during the early days of your corporation.
This blog is presented for information purposes only. Setting up a corporation is a complex legal activity and the points presented here should not be considered as legal advice.