Perfecting The Agreement For Selling A Closely Held Business

Wednesday, October 29, 2003

John Scroggin, Scroggin & Associates, Roswell, GA, Abstracted from: Avoiding Mistakes In Buy-Sell Agreements (With Checklist), http://

The Practical Lawyer - Vol. 49, No. 3, Pgs. 41-60

Overview: Describes the who/what/when/where/why/how of drafting an agreement to sell a closely held company. Outlines questions to consider in drafting a comprehensive agreement that anticipates issues likely to arise, and mentions common drafting errors. Uses the journalists technique to frame the information, and appends a practice checklist.

Why: the purposes.
Counsel to a closely held business with multiple owners must know how to draft an effective agreement covering the sale of stock when one of the owners dies, retires, or becomes incapacitated, John Scroggins urges. A primary purpose of the buy-sell agreement is to control who owns the shares. These restrictions are particularly important for S corporations, which can have only certain types of stockholders. Most agreements include a right of first refusal that requires the exiting stockholder to offer the shares to the other owners before transferring them. The agreement also should anticipate how additional capital contributions may be made, if all stockholders must agree, and whether stockholders may (or must) make contributions proportionate to their ownership interests. Drafters can take a number of approaches to settling disputes including arbitration, mediation by a third party, and put/call options, and may include negative covenants as well as an outline of the compensation structure.

Who: the parties to the agreement.
Agreements generally provide that either the company will redeem the shares of the exiting shareholder or that the other shareholders may or must purchase the stock. If the company is obligated to purchase the shares, the author suggests, it should be named as a party to the agreement. Having the company redeem one shareholders interests usually results in another shareholder gaining a majority interest. If a goal of the buy-sell agreement is to prevent any one shareholder from having control, it should set restrictions on the majority shareholders voting rights. The agreement and the stock certificates should indicate that all shares, including those issued in the future, are subject to the restrictions in the agreement.

When: the triggers.
The buy/sell obligations in the agreement generally are triggered in the event of death or disability (which may be difficult to define). If married stockholders divorce, the agreement may provide for the purchase of the ex-spouses shares. A change in the ownership of a stockholder that is a corporation may also trigger a purchase option. The author advises that when all of the company shares are to be sold in a block sale, no minority stockholder should be allowed to hold up the sale by exercising a right of first refusal. The drafter could provide for voiding rights of first refusal if a supermajority of shareholders vote in favor of the sale. Triggers should also reflect the tax implications of various choices and minimize the consequences.

How: the purchase price.
The author describes a number of approaches to setting the purchase price of the shares. For example, have a third party set the price; agree that the shareholders will set the price annually; or use a put/call arrangement. If the purchase is a result of death or disability, perhaps the remaining shareholders should pay a reduced price because the loss of the departing shareholder may have a negative impact on the business. Sometimes the company needs to pay for redeemed shares using an installment note. The agreement should limit new liabilities, and the noteholder should receive collateral in addition to the shares sold.

Abstracted from The Practical Lawyer, published by ALI-ABA Committee on Continuing Professional Education, 4025 Chestnut Street, Philadelphia, PA 19104-3099.

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