Stockholders’ Agreements: Plan Ahead for Owner Exits

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Owners of small and mid-sized businesses can spend nearly all of their time running their business, and many times, they do not make time to consider the life changing events that should be addressed in their stockholders’ agreement. Owners hope that the good relationships between owners today will naturally carry forward into the future.

Yet, lack of agreement on the terms of such stockholders’ agreement can have a substantially negative impact on these relationships when certain trigger events occur, resulting in a dispute and sometimes litigation between the owners.

Owners will many times complete the basic legal documents for their entity – as examples, articles of incorporation, bylaws, and organizational minutes
for a corporation – but the owners fail often times to discuss and finalize the trigger events of their stockholders’ agreement (also known as a buy-sell agreement). Such an agreement will address restrictions on transfer of stock held by the owners. Such an agreement will also address control with respect to the board of directors.

Negotiations regarding stockholders’ agreements in the early stages of a company can be grossly different from those involving a dispute or litigation down the road. Over the years of running a business, the good relationships between the owners can become damaged for many reasons – including, for example, changes resulting from one’s stage in life, and disagreements about the path forward for the company. Many times, the owners are relatives or friends who went into business together – and such disputes destroy more than just the business relationship.

While the stockholders may own differing percentages of the business, they may agree that certain stockholders should also serve on the board of directors. Instead of relying only on the annual vote of the stockholders for the election of the board of directors, the stockholders’ agreement can require that the other stockholders vote to elect a certain stockholder to the board of directors so long as such person is a stockholder or owns at least a certain percentage of stock.

Eventually, one owner may solicit or receive a third party offer to purchase the owner’s stock. The other owners may not want to be in business with this third party. Accordingly, the stockholders’ agreement can provide for an option for the company to purchase the stock at the terms and conditions offered by the third party. In the event that the company does not purchase the stock, the stockholders’ agreement can provide for purchase of the stock by the other stockholders.

The death of an owner raises many issues that must be promptly addressed. When an owner dies, the other owners may not want to be in business with the deceased owner’s spouse. It is also possible that such deceased owner’s spouse may not want to be involved in or own the business and would rather have the cash and other consideration. The stockholders’ agreement can require that the company will purchase the stock owned by the deceased owner.

Similarly, disability of the owner must be considered. When an owner is disabled, he may no longer desire or be able to work in the business and carry out his current duties. The stockholders’ agreement can require that the company will purchase the stock owned by such owner. Other trigger event situations should be considered. A few examples include the bankruptcy or divorce of the stockholder, or the termination or resignation of an employee who owns stock in the business. The stockholders’ agreement can provide an option for the company to purchase the stock in such situations.

Many times, the owners do not address the question of how to fund transactions of the stockholders’ agreement. As the business continues to grow, the purchase price may be in the millions of dollars for small and mid-sized companies. Insurance products are available to fund the purchase of stock upon the death or disability of an owner. Such insurance products should be considered and can be required in the terms of the stockholders’ agreement.

Even if there is only one owner, the buy-sell concepts can be implemented. A one way stockholders’ agreement allows an employee to agree to purchase the owner’s stock upon future trigger events. Such agreements can also be funded with insurance products with the annual premiums paid by the company.

Even when there is clarity about when a sale is to occur, the stockholders will many times have substantially differing opinions about the value of the business. These opinions can be more extreme when the discussions include parties that are not regularly involved in the business. The stockholders’ agreement should provide a means for determining the value of the stock and should define the payment terms. The agreement can also require that the owners set the value on an annual basis.

In conclusion, advance planning is critical for the smooth transition of a business when the unexpected happens. The death or disability of an owner or the sudden termination of a key employee can be detrimental to a business, and to such owner’s spouse and family. The stockholders’ agreement allows for planning for such trigger events and the funding of the resulting purchases.

ABOUT THE AUTHOR: Vasilios Peros
Vasilios Peros is founder and principal of Law Office of Vasilios Peros, P.C. His practice is focused primarily on business, technology, and intellectual property law. He has been recognized as one of SmartCEO’s 2016 Centers of Influence, 2015 CPA + ESQs, 2014 Power Players, and Legal Elite in 2011, 2010 and 2009.

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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.

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