MenuCoronavirus placed unprecedented challenges before businesses and their shareholders (and LLC members), particularly those who did not plan for the future. When times get tough, a business shareholder’s true colors can surface in unpredictable ways. I see how shareholders’ responses to the Pandemic created conflicts with fellow shareholders about the best way to operate the business. As a result, some shareholders have resolved to obtain a business divorce[1] after the virus subsides. But the ease with which this can occur depends on (i) their personalities, and (ii) whether they have a buy/sell agreement (“BSA”) in place.[2]
I briefly discuss below important factors that investors should consider when negotiating a mutually-acceptable BSA that enables shareholders to exit a business on agreeable terms. For more details, call the experienced lawyers at George Law any time at (248) 470-4300.
When Can a Shareholder Exercise the Buy/Sell Agreement?
A BSA generally sets forth when a minority investor may exit the company, and when the majority investor buy-out the minority investor’s interest. These rights are commonly called:
- Redemption Right – majority investor’s right to buy the minority investor’s interest
- Put Right – minority investor’s right to force the majority owner to buy their interest.
The parties may invoke their redemption right or their put right as the BSA provides; i.e., as they agreed. For example, in uncertain times like now, the parties may agree that neither may trigger the buy/sell until the company gets past uncertain times. Or, the minority investor may also want to protect itself from the majority investor selling its interest at an inflated price shortly after exercising its redemption right.
Determining the Value of the Interest
After the party has provided notice that it is exercising its right to buy or sell the minority shareholder’s interest, the parties must determine its value (i.e., purchase price). It’s not as straightforward as it may seem. In addition to deciding whether minority discounts apply – discussed below – the parties have to place an actual dollar value on the minority interest in the business. A well-drafted BSA will set forth the method that they will use.
For example, the buy/sell agreement can require the parties to use a defined formula for determining value, such as a multiple-of-revenues. This is simplest. More commonly, though, the BSA has the party who triggers the BSA, or both parties, retain a business-valuation expert to calculate the company’s value. If both parties hire an expert, the BSA typically requires the two experts to hire a third expert; the 3 company valuations are averaged to determine a final number.
When calculating the value of the interest, do the experts include a “minority discount”? I’ve seen as much as a 60% reduction in value if the experts discounted the value based on its lack of (i) marketability, and (ii) control in operating the business. Whether this discount applies depends on a number of factors, such as how long the minority investor delays before triggering the buy-sell option. There are a number of factors to consider, and the experienced lawyers at George Law can help. Call any time at (248) 470-4300.
Paying for the Interest in a Buy/Sell Agreement
The majority shareholder rarely pays cash for the minority interest in one lump-sum payment. Instead, it usually pays the purchase price in a series of payments over time. The majority shareholder’s payout usually includes a number of factors, such as (i) the down payment, (ii) how long the majority owner has to pay the balance of the purchase price, (iii) whether and how much interest is paid, and (iv) whether the majority owner provides collateral in case it defaults in paying the purchase price.
Conclusion
Business partners leaving a company they may have founded and helped make a success, can lead to unfortunate disagreements. Avoid as much of the brain damage as possible by having a buy-sell agreement in place. If you’re on good terms, now is a good time to adopt one. Make your business divorce go smoothly. Call the experienced lawyers at George Law any time at (248) 470-4300.
[1] I first saw the phrase “business divorce” used by an outstanding Dallas attorney, Ladd Hirsch.
[2] The absence of a BSA complicates a separation. It can be done, but the shareholders have to sit down, reasonably negotiate, and adopt a mutually-beneficial shareholder-exit plan. Their ability to do so will avoid a lengthy, expensive dispute that could harm the company and destroy long-standing personal relationships.