A shareholders’ agreement, also called a buy-sell agreement is a contract made between the shareholders of a corporation which sets forth the terms upon which the shareholders can sell or transfer their shares. A shareholders’ agreement also sets forth the terms for the other shareholders to purchase the shares of a shareholder that is retiring, disabled, deceased or wants to sell his shares.
A buy-sell agreement contains important provisions such as:Notice requirements to other shareholders before shares can be sold or transferred;
Formulas or rules for determining how the price of the shares will be calculated;Methods to fund the purchase of the company’s stock by other shareholders, such as life insurance or disability insurance policies; and
Restrictions on a shareholder, executor, trustee or heir offering the stock for sale to third party purchasers.
Reasons to Make a Shareholders Agreement
A shareholders’ agreement offers many benefits to the owners of an S-corporation, limited liability company or partnership. It can prevent disagreements or deadlock among the owners in the event of the disability, retirement, sudden departure or death of a shareholder. Because a buy-sell agreement places restrictions on the sale or transfer of a company’s stock, it can prevent a shareholder or his spouse, heirs or estate from selling the shares to a person or company the other shareholders do not want as a co-owner of the business.A shareholders’ agreement gives the non-selling shareholders a first right of refusal to purchase the shares of a selling shareholder if the selling shareholder becomes disabled, retires, divorces, wants to exit the business or dies. Because a buy-sell agreement provides a process for notices, responses, timelines, and valuation of the shares, it gives all owners of the business a level of certainty regarding the ownership structure of the company.A shareholders’ agreement is extremely important in estate planning, especially if there is no public market for the shares. If your company stock or partnership interest is a significant part of your estate, a buy-sell agreement is as important to your estate plan as a will, living trust, and power of attorney.
Life Insurance and Buy-Sell Agreements
Life insurance can be used to provide liquidity to fund the surviving shareholders’ purchase of a deceased shareholder’s stock. Life insurance companies offer several different types of policies to fund the purchase of shares at the death of a shareholder or partner, ranging from individual policies to group policies. See need for liquidity.
If your spouse or children depend on the income from your stock in the company, consider purchasing a personal life insurance policy to replace the income from the business, in addition to any separate life insurance the shareholders or the company may purchase to fund the buy-sell agreement.
Life insurance can have serious tax implications. For example, life insurance can affect the valuation of your corporate stock for estate tax purposes. Consult a tax professional for guidance before purchasing life insurance.
Use of Buy-Sell Agreements in Estate Planning
A shareholders’ agreement establishes the process your executor, trustee, heirs or beneficiaries must follow with regard to your stock in the company. For example, if your spouse inherits your shares, he or she will have to follow the procedures set forth in the shareholders’ agreement by notifying the co-owners of your death, offering the shares for sale to the surviving shareholders within certain timelines, and complying with the agreement with regard to any sale or transfer of the shares to any third party.You should include provisions in your will or living trust regarding whom should inherit your stock and note any restrictions on the sale or transfer of the stock. Explain to your executor and beneficiaries they cannot sell or transfer the shares without following the terms of the shareholders’ agreement and corporate bylaws. If your beneficiaries rely on income from your business for financial support, or if your estate will need to sell your stock quickly to pay outstanding debts, it’s important you discuss with your executor and beneficiaries how the stock must be handled upon your death.If you execute a living trust as part of your estate plan, you will need to title your shares in the name of the living trust. To have corporate stock pass outside of probate according to the terms of your living trust, the shares must be issued in the name of your living trust, not your name. If you have not received the share certificates yet, have the corporation issue them in the name of your living trust. If they have already been issued, you may need to fill out an assignment form to assign the shares to your living trust. The corporation needs to record this assignment in their records as well. If you fail to have the stock titled in the name of your living trust, the shares will pass according to the laws of intestate succession or your will. Contact the corporate secretary of the corporation for information on how to properly transfer the shares to your living trust.As part of your estate plan, you should execute a durable power of attorney for finances that gives your agent authority to sell, transfer and vote your shares in the event of your disability or incapacity. See granting power of attorney. If you are disabled or unable to communicate for any length of time, it could cause significant disruption of the business. A durable power of attorney for finances allows you to appoint an attorney in fact to make decisions for you in these circumstances. If you executed a buy-sell agreement, discuss it with the agent that will serve as your power of attorney and let him or her know where the buy-sell agreement is located. Include pertinent information in a Letter of Instruction about your estate plan. Store your shareholder agreements, stock certificates, and related documents in a home safe, fire proof cabinet or another secure form of storage. Because your passwords may be critical to continuing operation of the business, you should also keep a password record book where your agent or executor can locate it.
How Does a Shareholders Agreement Work?
Every shareholders’ agreement is unique. However, in most buy-sell agreements, when a shareholder wants to sell his shares, or if the shares pass to his heirs upon death, the shares must be offered for sale to the other shareholders in a written notice. The remaining shareholders, called the non-selling shareholders have a certain number of days to respond to the notice and indicate whether they wish to purchase the shares of the selling shareholder. If the non-selling shareholders do not wish to purchase the shares, the selling shareholder or his heirs may offer the shares for sale to a third party. In some buy-sell agreements, the non-selling shareholders or the corporation are required to purchase the shares. This is called a forced buyout.
The shareholders’ agreement usually provides a formula for determining the price the non-selling shareholders or the corporation will pay for the shares. If an appraisal method is to be used, the agreement may outline how the appraiser is to be selected.If the corporation or the shareholders plan to use a life insurance policy or disability insurance policy to fund the purchase of the shares, the buy-sell agreement may outline which party is responsible to pay for the insurance, the amount of insurance to be purchased, and how any excess insurance proceeds should be distributed.
There are many factors to be considered when drafting a buy-sell agreement, such as applicable state laws, corporate bylaws, accounting issues, estate tax laws, and prior agreements or commitments by the corporation. Consult an attorney and a tax professional before executing a shareholders’ agreement or adding buy-sell provisions to your corporate bylaws.
Spousal Consent to a Buy-Sell Agreement
If you are married or have a domestic partner, your spouse or partner may be required to sign a spousal consent form agreeing to the terms of the shareholders’ agreement. A spousal consent is especially important if you reside in a community property state or if the shares are considered jointly-owned property.
Information for Executors and Trustees
If you are an executor or trustee of an estate or trust holding stock that is subject to a buy-sell agreement, you should carefully review the corporate bylaws, buy-sell agreement, and any restrictions printed on the stock certificates prior to transferring or selling the shares. Consult a probate lawyer for assistance.
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