30 Sep What buyout triggers should be structured into the buy-sell agreement?
The buy-out triggers are those events that trigger one party’s right or obligation to buy the stock of another party under the agreement. The most common triggers in any buy-sell agreement among the shareholders include the death of an owner, the disability of an owner, the voluntary employment termination of an owner who is also an employee, the divorce of an owner, bankruptcy of an owner, the desire of an owner to just cash out and move on, and the expulsion of an owner. Triggers in a buy-sell agreement provide shareholders with an easy exit or buyout ability. Sometimes it’s nice to be able to hold on to the business and suck the cash flows for a long time, but change is the only constant. Change unfortunately acts as the triggering agent in most of these types of deals. Each of these triggering events creates a unique set of problems and may require a different solution.
Take death as an example. In the case of ABC Inc. it’s likely the agreement should be structured to provide that if one of the 20% stockholders, that’s Roger or Joyce dies, his or her stock will be purchased by the other shareholders or by the company. Certainly, Dave and Sue, the majority shareholders, would want the comfort of knowing that they could purchase the stock of Roger or Joyce if one of them should die. Also, Roger and Joyce would want to ensure that their stock would be cashed out at a fair price in the event of an untimely death. But if Dave were to die, it’s doubtful that his stock should be bought by the other shareholders or redeemed by the company. Sue may want the stock or perhaps Dave would want the stock to be left to his son Sam. There’s no requirement that all shareholders be treated the same under these various triggering events.
Disability presents unique problems. Usually, a disability trigger applies only to owners whose interest in the business are tied to their employment by the business. For Roger or Joyce, a disability trigger makes sense but it likely wouldn’t be needed or wanted for Dave or Sue. Often the trigger operates in favor of the company and the disabled employee, that is, either party can trigger the buyout. The parties initially must agree on a definition of a disability and a process for determining whether an employee who is also a shareholder is actually disabled.
Often it is asked, why is it advisable to have divorce and bankruptcy included as triggering events in an agreement? The purpose of these provisions is to protect the company and the other shareholders if a stockholder’s stock becomes tangled up in a messy divorce or bankruptcy proceeding. If either Roger or Joyce got tangled up in a divorce or bankruptcy hassle that put their stock in play, the other shareholders of the company would want to have the option to purchase the stock at a fair value to keep the company out of the mess. If the particular proceeding does not disrupt the company or pose any threat, there may be no reason for the company or the other shareholders to exercise their rights under the agreement. But it the attorney of a spouse who’s upset or a bankruptcy trustee attempts to cause problems or create uncertainty for the company b exercising control over a block of stock, the buyout rights can be effectively used to neutralize any threats.
Expulsion usually is a difficult trigger for owners to discuss and resolve. Nobody likes to think about kicking one of their own out the group. Many organizations really don’t need or want an expulsion provision. And in some family businesses, it’s just too divisive. But in some other organizations where the owners are the principal employees in the business, often there is a need to develop a mechanism to permit the group to throw out the bad apple and purchase his or her stock. In the absence of such a trigger or prearrangement, you run the risk of the potential for long-term survival of the business. The trigger sometimes is structured to require the unanimous or a super high majority vote, say, 75% of all the other owners before the trigger can be pulled. Careful discussion usually is required on this trigger.