Corporate Law: Buy-sell agreements ease ownership transition

Stephen F. Aton is a Springfield attorney practicing corporate law and taxation, estate planning and probate law.

A majority of small businesses in the United States have fewer than three owners. These owners have chosen to work together by choice, and in the event of the death or disability of an owner, the remaining owners would normally wish to continue the business by purchasing the interest of the deceased or disabled owner. However, if the owners have not planned for this possibility, the transition may prove harmful to the business.

For example, assume three friends start ABC Widget Inc. They incorporate the entity and issue stock in equal shares to each. Each of the three works in the business as his sole endeavor and is paid a fair salary for his contribution to the success of the company.

Without warning, one of the stockholders passes away and the company has failed to plan for such an occurrence.

The deceased stockholder's share now is owned by his estate, which will be distributed to his four children, one of whom is notoriously difficult to get along with and was estranged from the deceased shareholder.

While the two original shareholders still have a majority of the shares, they now have a vocal group of minority shareholders to question their business decisions.

If there had been only two shareholders in the company, the results could have been devastating, for neither shareholder would have majority control of the company.

The shareholders should have planned ahead by having a buy-sell agreement drafted to cover the death, disability or sale of stock by any of the shareholders.

The members of a limited liability company, or the partners of a partnership, should take similar steps to ensure that an interest of their business does not pass to someone who would jeopardize the success of the company.

Buy-sell agreements typically state that upon the occurrence of any of several events, such as the death, disability or desire on the part of an owner to sell, the remaining owners have a right of first refusal to purchase the interest. If they do not elect to purchase the interest, it passes free of the transfer restriction.

The price for the interest to be purchased is sometimes fixed in the buy-sell instrument, but unless the number is reasonable, it may be subject to a challenge in court by the party that is bound by it. Often a formula will simply state how the purchase price is to be determined. The formula may be based on book value, capitalized earnings a bona fided offer to purchase the interest by an outside party.

Without a buy-sell agreement, business owners are taking a risk that their co-owner's part of the company will pass to an acceptable party. The results will almost always be more beneficial to all involved if the issue is addressed and agreed to at the time the company is formed.