Tilly & Fitzgerald
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PLANNING FOR STOCK TRANSFERS THROUGH BUY-SELL AGREEMENTS
By Craig A. Fitzgerald
Smith and Jones each own fifty percent of the stock of ABC Corporation. One day, Jones decides to retire and wishes to terminate his interest in ABC. Should Jones be entitled to sell his stock to anyone he chooses? What happens to Smith's stock if he passes away? Should Jones be required to purchase Smith's stock? If so, how should the value of Smith's stock be determined and how will Jones pay for the stock?
Smith and Jones could avoid numerous potential problems by addressing these questions in advance in a Buy-Sell Agreement, sometimes referred to as a Stock Purchase Agreement or a Wait and See Stock Purchase Agreement. Although an endless possibility of provisions may be incorporated in a Buy-Sell Agreement, all Buy-Sell Agreements should address several basic areas.
Voluntary and Involuntary Transfers - The first area a Buy-Sell Agreement should address is the voluntary and involuntary transfer of stock. Most shareholders of closely held corporations view their fellow shareholders as partners, and are very selective in choosing such shareholders. Therefore, a common provision in Buy-Sell Agreements restricts the ability of shareholders to transfer ownership of their shares and gives the corporation and/or the non-selling shareholders a right of first refusal on the shares being sold. Such restrictions are permitted under Okla. Stat. tit. 18, § 1055. These restrictions typically apply both to voluntary transfers and involuntary transfers, such as sales required by divorce and executions by judgment creditors.
Typically, the selling shareholder will notify the remaining shareholders of an impending sale, and the identity of the purchaser. If the non-selling shareholders do not approve of the purchaser, they can exercise their right to purchase, or cause the corporation to purchase, the shares of the selling shareholder. If the non-selling shareholders choose not to exercise their right of first refusal, the selling shareholder is free to sell only to the person identified in the notice. Such provisions allow the non-selling shareholders to maintain control over the persons with whom they are co-owners, while not unduly restricting the ability of the selling shareholder to liquidate his investment.
Deceased or Disabled Shareholders - Another area to address is the purchase of the stock of a disabled or deceased shareholder. Normally, the Buy-Sell Agreement requires the corporation and/or its shareholders to purchase the stock of a shareholder who is disabled or deceased. These provisions relieve the family of the disabled or deceased shareholder from the burden of locating a purchaser for the shares. In addition, it provides an easy means of liquidating assets of the disabled or deceased shareholder when needed the most. These provisions also assure the remaining shareholders that corporate profits are not distributed among shareholders who are unable to contribute to the success of the corporation.
Purchase Price - A Buy-Sell Agreement should also set forth the method of determining the purchase price of the stock. Often, the most difficult aspect of selling stock of a closely held corporation is determining a fair purchase price. Depreciation, book value, fair market value, and other accounting concepts make it difficult to determine the value of the assets. Complicating matters is the fact that much of the value of small companies does not lie in the assets of the company, but in the ability to generate income.
Usually, the shareholders will attempt to arrive at an agreed value, incorporate the value into the Buy-Sell Agreement, and agree to revise the value each year. However, the shareholders should also devise a formula for determining value in case they do not, or cannot, agree on a revised figure. The appropriate formula will vary with each business. Your Certified Public Accountant can probably provide useful assistance in devising a formula.
Methods of Payment - Finally, a Buy-Sell Agreement may provide a method of paying for the stock of the selling shareholder. Raising sufficient funds to purchase the entire interest of a co-owner often creates problems, especially when the purchase is required because of the disability or death of a shareholder. Consequently, Buy-Sell Agreements typically require the corporation or the shareholders to purchase disability and life insurance on each shareholder in an amount sufficient for the corporation and/or non-selling shareholders to pay the purchase price. In addition, sometimes the agreement provides for an installment purchase of shares so the purchasing shareholders are not required to raise the entire purchase price at once.
Each of these areas will require thoughtful discussion among the shareholders and with your attorney. In addition, your attorney will include several other useful provisions regarding the logistics and legal effect of the agreement.
If the shareholders of your corporation have executed a Shareholder Agreement, you may already have addressed many, if not all, of these potential problems. While Shareholder Agreements usually address the management of the corporation and how the shareholders will vote their shares, they often address the purchase and sale of stock as well. Before contacting an attorney, review your Shareholder Agreement to determine if the above areas are adequately addressed. If not, a Buy-Sell Agreement is a relatively inexpensive way to eliminate potential problems in advance, and to help all shareholders be more satisfied with a change in ownership.