D. How to Use This Book

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BUY-SELL AGREEMENT HANDBOOK



Icons Used in This Book

Throughout this book, these icons alert you to

certain information.

Fast Track. We use this icon to let you

know when you may skip information

that may not be relevant to your situation.

Warning. This icon alerts you to potential

problems.

Recommended Reading. When you see

this icon, a list of additional resources

that can assist you follows.

Tip. A legal or common sense tip to help

you understand or comply with legal

requirements.

See an Expert. Lets you know when you

need the advice of an attorney, accountant or other expert.

Cross Reference. This icon refers you to

a further discussion of the topic elsewhere in the book.

Worksheet. When you see this icon, the

text will tell you to make a notation or

check an option on your worksheet, as explained

above.



One practical suggestion: Take it easy. As you

read through the book for the first time, you may

feel a bit discombobulated by the numerous

possibilities that can be covered in a buy-sell

agreement. Expect to feel a bit overwhelmed. Not

every company needs to cover every contingency.

And there’s no need to grasp every detail the first

time through. Start by reading the entire book to

get a rough understanding of what’s involved and

making a few observations on your worksheet



about what situations or provisions might be

particularly applicable to you.

Then spend time considering what you want to

happen to your business when you are no longer

in charge; creating a buy-sell agreement has important, long-term consequences for you and your

family, and your finances. Allow plenty of time

for discussions with your co-owners—talk, argue

and speculate. Perhaps give each owner a

worksheet of their own to fill out. When you’re

ready, go back, focus on the areas of most concern and begin to pin down exactly what you

want in your agreement.

When you’ve all agreed on your decisions,

you’ll simply transfer your choices from your

worksheet to the blank buy-sell agreement we

provide. You’ll end up with an agreement that

can handle all the predicaments that we discussed

above, as well as a few more.

Check your agreement with an expert.



While we provide a lot of information, we

cannot provide the depth of advice, especially in

the tax and estate planning realms, that a buy-sell

or financial planner or a tax expert can provide.

And of course, since we don’t know you and

your particular business, we can’t customize an

agreement for you that exactly suits your

company’s and each owner’s individual needs,

though we do make every attempt to provide

different alternatives and tips on customizing your

own agreement.



AN OVERVIEW OF BUY-SELL AGREEMENTS



So, in general, we recommend you bring your

draft buy-sell agreement to a small business tax or

legal advisor before putting your finalized agreement into action. Consultations of this sort are

invaluable to make sure that you have considered

all the relevant tax angles and the contingencies

that apply to your particular business. If the needs

or circumstances of the owners are substantially

different, each owner may wish to check out the

tax and estate planning repercussions with his or

her individual tax advisor or financial planner.

Although you must pay professional fees for

document review and any additional individual

consultations with your tax specialist, you’ll still

save thousands by not asking a small business

lawyer or tax advisor to create your buy-sell

agreement from scratch. In Chapter 10, we

discuss how to find a legal “coach”—a helpful

professional who will review your papers and

double-check your self-help legal efforts.

In addition, a lawyer can make sure that your

new buy-sell provisions don’t conflict with existing provisions of your business’s organizational

documents—your articles or bylaws or partnership agreement or LLC operating agreement. See

Chapter 8, Section A for more information.

If you decide to have an expert prepare your

buy-sell agreement rather than do it yourself,

you’ll benefit greatly by knowing the critical issues and what your options are. You may want to

create a draft of a buy-sell agreement—or at least



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fill out the worksheet—and bring it with you to

your first meeting, along with any questions you

have. It will help your planner immensely in

knowing where you’re at and what you want out

of an agreement, saving you time and money.

Of course, planning in advance to contend

with likely disputes is not the same thing as saying you can prevent change. For good or bad,

your ownership situation is almost sure to be different five years hence. The point is that crafting

a good buy-sell agreement can make this process

as positive as possible, and will help you avoid

change’s most unfavorable aspects. So, as you

read about all the horrible things that can happen

to a company and its owners, don’t let the specter

of changes of ownership and resulting conflicts

get you down.

Remember why you started your own business.

Doing your own thing allows you to work with

people you enjoy and to control your own

destiny. A buy-sell agreement will make sure it

stays that way. Getting along with your co-owners

and making decisions together from the start can

make a world of difference in the future of your

company. Begin by being frank with your coowners and family members now. We are

confident that reading this book closely with your

co-owners will leave you with a comprehensive

buy-sell agreement that will protect you and your

co-owners for years to come.

■



CHAPTER



2

Limiting the Transfer of

Ownership Interests

A. Transferring Ownership Interests ...................................................................... 2/2

B. Right of First Refusal ......................................................................................... 2/2

1. What If an Owner Wants to Sell Her Interest to an Outside Buyer? ............. 2/2

2. What If an Owner Wants to Sell His Interest to a Current Owner? ............... 2/7

3. What If an Owner Wants to Give Away Her Interest (or Put It in a Trust)? ... 2/8

C. Absolute Transfer Restrictions ......................................................................... 2/11



2/ 2



BUY-SELL AGREEMENT HANDBOOK



I



n an age when many people change jobs or

even careers a number of times during their

adult life and when businesses are opened

and closed with head-spinning speed, it’s a bit of

a risky bet that you and your co-owners will all

be doing the same thing even five years from

now. At some point during the life of your business, you or one of your business’s co-owners

will probably want to sell your interest in the

business and move on to do something else. For

that reason, the most common event that can disrupt a small business involves an owner’s wanting

to sell or transfer her interest in the company.



A. Transferring

Ownership Interests

One way an owner might try to transfer her interest is to sell it to an outside buyer (anyone not a

current owner)—assuming she’s lucky enough to

find one. Another, probably more likely, sales

scenario is for one or more of her co-owners to

purchase her share (or for the company itself to

buy the interest back). Or, an older owner may

want to transfer all or part of her ownership

interest to a trust, or give it to her children as part

of her estate planning.

To help you and your co-owners maintain

control of your company, it’s essential to create in

advance an impartial method for reviewing potential ownership transfers and blocking any undesirable ones. The best way to do this is to adopt a

buy-sell provision that gives the company or co-



owners the right to buy an owner’s interest before

it’s sold, given away or otherwise transferred

(called a “Right of First Refusal”). This provision

covers all the scenarios discussed above; essentially, it covers any attempt by an owner to transfer

an ownership interest in the company—by sale,

gift or otherwise.



B. Right of First Refusal

To avoid the scary possibility that an unwanted

person might buy (or otherwise be transferred) an

interest in your business, most buy-sell agreements

sensibly contain a “Right of First Refusal”

provision requiring an owner to first offer his

interest for sale to his company and co-owners

before selling it or transferring it to anyone else.

Depending on the needs of your company, you

may want this type of restriction to apply only

when an owner considers transferring his interest

to an outsider. But there can also be reasons why

you might want this type of restriction to apply

when an owner is considering transferring his

interest to an insider—a current owner.



1. What If an Owner Wants to Sell Her

Interest to an Outside Buyer?

Should a co-owner have the unconditional right to

transfer his interest in the business to someone who

is not already an owner of the company? Although

at first thought you might be tempted to say, “Why

shouldn’t an owner be able to do whatever he

wants with his interest?”—think again. Consider that

if you happen to be one of the continuing owners

in the company, you might be horrified if a coowner were to sell out to an unqualified, uninformed or just plain ornery new owner, who—even

if she purchased a minority share—would have

much power to make your life miserable. And, of

course, things would be far worse if an outsider

stood to gain a majority interest in your company,

since this would give her an opportunity to all but

take your company away from you.



LIMITING THE TRANSFER OF OWNERSHIP INTERESTS



EXAMPLE: Brothers Frank and Eldon, along



with Eldon’s wife, Ethel, open a boutique

computer store and service business. They

create a corporation with each relative owning

a one-third stock interest and each serving as a

board member. No buy-sell agreement is

prepared. A few years later, after the service

part of the business has become successful, they

receive a favorable buyout offer from a competitor—an owner of a chain of inexpensive

computer stores. Frank has no interest in selling his shares—he wants to keep the business

in the family and eventually have his daughter

Emily succeed him. Eldon and Ethel, on the

other hand, have been looking forward to early

retirement and jump at what they see as a

golden opportunity to cash out. Since neither

the corporate law in their state nor the

corporation’s bylaws require all owners to approve a transfer of an owner’s shares in the

corporation, Eldon and Ethel sign a contract to

sell their two-thirds ownership in the company

to the chain operator. The new owner quickly

votes her newly acquired, two-thirds controlling interest to elect herself and her husband

to fill the two recently vacated board seats.

Frank is left with a one-third interest in a business that he can no longer run independently.

A “Right-of-First-Refusal” provision gives the

company, and usually the continuing

(nontransferring) owners individually, the choice

to buy a co-owner’s interest before an outsider is

allowed to make a purchase (or otherwise receive

an interest in the company). If the continuing

owners decide they do not want to work with a

prospective new owner, the company or the owners individually can exercise their right to buy the

transferring owner’s interest. On the other hand, if

the owners approve of the transferee potential

new owner, they can elect not to buy the coowner’s interest—essentially approving the sale

(or other transfer).

Here are the details of how our Right-of-FirstRefusal provision works with respect to potential

sales of an interest by an owner to an outsider.



2/3



(We discuss how our clause covers sales to insiders and gifts of interests—the two other most common types of transfers—later in this chapter).

When an owner receives an offer from an outsider

to buy his ownership interest, a Right-of-First-Refusal provision requires that owner (let’s call her

the “transferring owner”) to submit written notice

to the company of her intent to sell her interest,

along with the terms of the proposed sale. The

company and the continuing owners then have an

option to buy the interest (at the same price as or a

different price from that offered by the outsider,

depending on which price option is checked in the

buy-sell agreement—also discussed below).

If the company and the continuing owners

decline to purchase all of the transferring owner’s

interest, the transferring owner is free to sell her

interest to the outsider. The transferring owner

must, however, transfer her interest to the outsider within 60 days, at the same price and terms

stated in her notice, or she must start the whole

process over again before transferring her interest.

For example, if the transferring owner wishes to

lower the price to be paid by the outsider for her

interest, or wishes to change other terms of the

sale to the outsider to make them more favorable

(for example, a lower interest rate on installment

payments or a longer payment term), she must

submit to the company a new notice—essentially

starting the process over again for the transfer of

the interest under the new terms.

On the other hand, if the company and/or the

continuing owners decide they do want to purchase the entire ownership interest, the outsider is

out of luck. The company and/or the continuing

owners then buy the interest from the transferring

owner within a certain period of time.

EXAMPLE: Jason, Tim, Chris and Bart are four



equal shareholders and directors of a small

travel-adventure corporation called Run-aMuck. Jason wants to sell his shares to an outsider, Kacey. According to the Right-of-FirstRefusal provision in the corporation’s buy-sell

agreement, Jason must first get a signed written offer from Kacey, then notify the corpora-