I. What If an Owner Is Expelled?

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counting the buyout price according to possible

impairment of your company’s reputation. For instance, your agreement can allow the company or

the remaining owners to purchase the share of an

expelled owner at 50% of the full Agreement

Price to allow for the possibility that the coowner’s conduct has resulted in the business’s doing poorly. Or, you may simply want to provide

for a new appraisal of the company to establish

its current worth. (We discuss the procedure for

getting an appraisal in Chapter 6.)

Expulsion may be one area where you do not

want to allow binding arbitration. Arbitration



is a method of settling a conflict where a neutral

third party makes a decision rather than a judge

(discussed in Chapter 8). For many people, it’s

usually a better choice than going to court, but in

this situation, an arbitrator might decide you can’t

expel a partner or other co-owner when you

think it is absolutely necessary for your business’s

survival. So you may not want required arbitration

to apply to expulsion. To accomplish this, at the

end of your expulsion clause, add a declaration

that any expulsion decision is absolutely final and

is not subject to arbitration or other review, including review by any court. (This will make the

arbitration clause not apply, since the arbitration

clause in our agreement starts with the phrase,

“Except as otherwise provided in this agreement.”)

The expulsion clause included in our buy-sell

agreement is shown in Excerpt 13.



Worksheet. If you are interested in giving



the company and the continuing owners

the option to buy an expelled owner’s interest,

check Option 1 on your worksheet now. (Section

III, Scenario 8.)

If you check Option 1, you can choose to define adequate cause. If you choose to do so, you

may check one or all of the following:

• check Option 1a to include criminal conduct

as an instance of adequate cause

• check Option 1b to include breach of duties

as an instance of adequate cause

• check Option 1c to list your own reasons

for expulsion for adequate cause.

If you do not check any of these options, adequate cause will be determined at the time of

expulsion.

If you checked Option 1a, 1b or 1c, you must

choose the price to be paid for the expelled

owner’s interest:

• check Option 1d to use the regular Agreement Price, or

• check Option 1e to call for an appraisal of

the expelled owner’s ownership interest, or

• check Option 1f to use a discounted Agreement Price. If you check Option 1c, also fill

in the percentage amount of the discount to

be taken off the Agreement Price, such as

50%.

This provision applies only to businesses with

more than two owners. If you own your



business with one other person, you will not be

able to expel that person. So if your co-owner is

acting badly or not working up to par, unless you

convince her to sell out, your only other option

might be to disband the company.



PROVIDING THE RIGHT TO FORCE BUYOUTS



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Scenario 8. Expulsion of Owner

Option 1: Option of Company and Continuing Owners to Purchase an Expelled

Owner’s Interest

(a) At a time when the company has three or more owners, situations may arise in which a

group of owners wish to expel another owner. An owner may be expelled upon a

unanimous vote of all other owners for adequate cause. Upon such expulsion, the

expelled owner is deemed to have offered to sell all of his or her interest to the company

and the continuing owners. The company and the continuing owners shall then have an

option, but not an obligation (unless otherwise stated in this agreement), to purchase all

or part of the ownership interest within the time and according to the procedure in

Section IV, Provision 1 of this agreement. The price to be paid shall be as specified in this

section; if not so specified, then according to Section VI of this agreement. The manner of

payments and other terms of the purchase shall be according to Section VII of this

agreement. An owner who has been expelled is referred to as an “expelled owner”

below.

(b) Adequate cause includes, but is not limited to:

Option 1a: Any criminal conduct against the company (such as embezzlement)

Option 1b: A serious breach of the owner’s duties or of any written policy of the

company

[insert reasons]

Option 1c:

(c) If an owner is expelled for a reason listed in subsection (b), the price that the company

and/or the continuing owners will pay for the expelled owner’s ownership interest will

be:

Option 1d: The full Agreement Price according to Section VI of this agreement

Option 1e: Decided by an independent appraisal, according to the Appraised Value

Method in Section VI of this agreement

Option 1f: The Agreement Price as established in Section VI of this agreement,

decreased by [insert percentage, such as “50”] %



Excerpt 13



■



CHAPTER



4

Structuring Buyouts

A. Types of Buyout Procedures ............................................................................. 4/2

1. Entity-Purchase Buyback (Called a Redemption Buyback for Corporations) ... 4/2

2. Cross-Purchase Buyback .............................................................................. 4/4

3. Combination of Entity-Purchase and Cross-Purchase Buyback .................... 4/4

B. How Our “Wait and See” Approach Works ...................................................... 4/5

1. How Our Buyback Procedure Works With an Option to Purchase .............. 4/5

2. How Our Buyback Procedure Works With a Right of First Refusal ............ 4/11

3. How Our Buyout Procedure Works With a Right to Force a Sale .............. 4/11



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BUY-SELL AGREEMENT HANDBOOK



I



n Chapters 2 and 3, we discussed how you

can use buy-sell provisions—including the

Right of First Refusal, the Option to Purchase

an Owner’s Interest and the Right to Force a

Sale—to control who owns your company and to

give departing owners a mechanism to cash out.

If you include any of these provisions in your

buy-sell agreement, at some point during your

company’s life, the company or the continuing

owners will probably purchase a departing

owner’s interest. To ensure that all buyout

situations are handled smoothly, your buy-sell

agreement provides how a future buyout will be

carried out.

Our agreement’s buyout procedure includes

the following details:

• how and when the company and the

continuing owners decide who will buy the

ownership interest of the selling, departing

or deceased owner (we’ll call that owner the

“transferring” owner, and the ownership interest the “available interest”). In other

words, our agreement provides a framework

for deciding whether the company itself or

the owners who will remain in the company

(we’ll call them the “continuing owners”)

will buy the available interest.

• how and when the company and continuing

owners must notify the transferring owner

that they will purchase his or her interest

(using a Notice of Intent to Purchase an

Owner’s Interest).

We show you how our buy-sell agreement

handles these items below. The only choices

you’ll have to make in this chapter involve the

number of days for decisions, notices and the

like.



A. Types of Buyout Procedures

There are three main approaches to implementing

a buyout. The main difference among these methods involves who will buy the transferring

owner’s interest—the company or the continuing

owners, or a combination of the two.



We present these three common methods of

buying back interests below. (Our agreement uses

the third method, for the reasons explained below.)



1. Entity-Purchase Buyback

(Called a Redemption Buyback

for Corporations)

In this first type of buyback procedure, called an

“entity-purchase buyback,” when an owner

retires, dies or wants to sell out, only the company (the “entity”) has the option, or sometimes

the obligation—depending on what clauses are

included in the buy-sell agreement—to buy the

transferring owner’s interest in the company.

What happens after the company buys the

available interest depends on how your business

is organized. In a corporation, the company simply

cancels the redeemed shares after a buyback, and

the continuing shareholders’ ownership percentages in the company increase accordingly (though

the amount of shares they own will not change).

Similarly, in a partnership or an LLC, after the

company buys an owner’s interest, the interest is

“liquidated,” and the continuing partners’ or

members’ ownership percentages increase.

The entity-purchase method is popular because

it allows company funds rather than personal

funds or personal loans to complete a buyout. But

the main advantage of this method is its simplicity.

By deciding who will buy the transferring owner’s

interest far in advance of the actual buyback, this

method eliminates the need to decide who will

make the buyback at the time of the buyout.

However, because this method is so simple, it

lacks flexibility. For example, it doesn’t give one

or more continuing owners the option of buying

the ownership interest themselves, an approach

that can sometimes result in significant income

and capital gains tax advantages to both the continuing owners and the transferring owner. In

short, since rapidly changing tax laws as well as

constant changes in companies’ and owners’ situations make it impossible to know years in ad-



STRUCTURING BUYOUTS



vance whether it would be best have the company or the continuing owners buy the interest in

question, a more informed decision can be made

at the time of the buyout.

We discuss the income tax disadvantages

of company-sponsored buyouts briefly in

Chapter 9, Section A. Note, however, that this is a

complicated area, and you will no doubt want to

get a tax expert’s opinion before having your

company or the continuing owners buy out an

owner’s interest.



Corporations and LLCs can’t always buy out

a departing owner. In most states, corpora-



tions and LLCs cannot absolutely bind themselves

to a plan to buy back the interest of a departing

owner. That’s because, to legally do this, the

company is required to be in good financial

shape—in other words, to have sufficient surplus

funds available before purchasing a transferring

owner’s interest. (See “Your Company Should Remain Solvent After a Buyback,” just below.)



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Your Company Should Remain

Solvent After a Buyback

As a rule, state corporation and LLC laws prevent a corporation or LLC from buying back an

owner’s interest if specific financial solvency

tests cannot be met. Generally, state law

requires that, after the buyback, the company’s

assets must exceed its liabilities (sometimes by

a specified amount). For example, a state may

say that a company’s assets must be at least one

and one-half times its liabilities after the

buyback. And, almost as a universal rule, to

participate in a buyback the corporation or LLC

must be able to pay its debts as they become

due after the buyback (that is, the company

must remain solvent after the purchase of the

owner’s interest). Rather than worry too much

about these restrictions now, just realize that in

the future, if your corporation or LLC would

have to use most or all of its cash reserves to

buy back a departing owner’s shares, it may be

illegal to go forward with the deal. But this

doesn’t mean there would be a legal impediment to one or more co-owners’ individually

buying back shares. Which, of course, is another way of saying that it’s important to have a

buy-sell agreement procedure that lets you decide at the time of the buyout who should buy

the shares of a transferring owner.

Partnerships should follow this solvency

test, too. While not normally required

under state partnership laws, it also makes

sense for partnerships to make sure that they

remain solvent after a company buyback of a

partner’s interest. Even if your partnership

agreement and state law allow your company

to pay more than it can afford to buy back an

owner’s interest, it would be foolhardy for it to

do so.