Despite their best intentions, owners of family-owned businesses frequently develop differences of opinions about compensation, day-to-day operations, leadership, financing, disposition of equity, and more. Shareholder agreements, which include close corporation agreements, operating agreements, and buy sell agreements, are an important part of any business strategy, providing a framework for sound governance and preventing misunderstandings that may result in litigation.
A close corporation agreement, often referred to as a "shareholders' agreement," is a legal document that outlines the business' ownership structure, management, and day-to-day operations. An operating agreement for limited liability companies functions in the same way. A well-crafted close corporation agreement or operating agreement will include mechanisms for decision-making, capital calls, voting rights, winding up and dissolving the entity, and dispute resolution.
A buy-sell agreement, or "buyout agreement," outlines the terms and conditions for the sale or transfer of shareholder or member equity. Buy-sell agreements may include an agreed upon formula, or a certificate of valuation, for a buy-out of one shareholder or member's interest. Regardless of the buyout mechanism, it should be understood by all parties, with input from business valuation experts, accountants, and legal counsel. The buy-out mechanism should also be reviewed yearly to ensure it is up to date. Buy-sell agreements may also include rights of first refusal, call options, put options and drag along rights.
Having both a close corporation agreement and buy-sell agreement in place provides numerous benefits to the company and its shareholders or members. They create a framework for sound governance and dispute resolution, facilitate transparent business practices and common understandings, and prepare for the smooth transfer of ownership interest. While incorporating these agreements into the family business plan would seem like a no-brainer, many closely held businesses operate without them, or with outdated agreements, which risks feuding, financial losses, and lawsuits.
Beyond having these contractual arrangements in place, shareholder or member agreements should be reviewed and updated frequently, especially as your company grows. Purchase price mechanisms should be assessed periodically to ensure that compensation paid upon the death, disability or departure of a shareholder or member is understood and fair to all parties. And life insurance should be maintained to fund a buyout of another shareholder or member's interest and to fund ongoing business operations.
By referencing and incorporating legal tools and best practices, family run businesses can create a long-lasting foundation for their company's ongoing success, now and in the future.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.