What is a Shareholder Buy-Sell Agreement and Why You Need One

When you start a new business, you’ll quickly discover there is not enough time in the day to accomplish everything you need or even want to do. Since so much time, energy and effort goes into to getting a business started, any time spent on administrative or organization issues can be a waste of your (valuable) time. However, spending a small amount of time on the fundamentals can help you avoid stress, and one of the first fundamentals is to set up a shareholder buy-sell agreement.

Shareholder Buy-Sell Agreement

A shareholder buy-sell agreement is an agreement amongst the shareholders of a company. This relationship is regulated by the constitutional documents of the company; however, if there are only a small number of shareholders it is common practice to supplement the constitutional document.

There are several benefits to including a shareholder buy-sell agreement in your business plan, including:

  • The ability to control the ownership of equity allowing the corporation’s stock to be held by only those actively involved in the business
  • Providing liquidity for the founders (and/or their heirs) if they become permanently disabled or die
  • Addressing potential disruptive governance issues

Why your business needs a buy-sell agreement

A buy-sell agreement triggers the right for corporations and other shareholders to buy shares that are held by a shareholder who’s exiting the company. In addition, terminating service triggers the option—highly in favor of the corporation—to purchase any (or all) of the shares held by the former founder or other key-employees. This is done either at a predetermined, formula-based price or by an appraised purchase price.

Moreover, depending on the nature of the current shareholder’s exit (whether they voluntarily exit or are terminated (with or without good cause)), the purchase price could be discounted.

Two of the more common triggers that allow for optional (or mandatory) purchase of shares are death or permanent disability. In the event of death or disability, this sale of shares is primarily for providing the shareholder or their families with funds to live or take care of final expenses.

If your start-up doesn’t have cash available to provide the liquidity for the deceased or disabled founder (and/or for the founder’s heirs), you can purchase insurance—at favorable rates—that will be able to cover the expenses. If no insurance is obtained, liquidity can be structured in installments over time to reduce the burden on the corporation to a manageable level.

A buy-sell can also contain certain provisions that:

  • Prevent shares from being held by a former spouse of a former founder or other key employee
  • Require shareholders to sell their shares if the other shareholders decide to sell their shares as part of the sale of the business
  • Allow other shareholders to share a pro-rata portion of their shares

MaxFilings can provide you with more information about forming a corporation and other aspects of ways to run your business successfully. If you are just starting a new business or are looking to help your business flourish, do not hesitate to check out our Knowledge Center.

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