As a shareholder, you will likely be privy to your company’s shareholders agreement. A shareholders agreement is used to govern the relationship between shareholders and the business. It contains key clauses relating to the business’ structure and what happens in certain situations. A common clause in a shareholders agreement is a business buy-out clause. This article will explain a business buy-out clause and what to consider when dealing with one.
What is a Business Buy-Out Clause?
A business buy-out clause is a term that is often included in shareholder or partnership agreements. It outlines the process for a shareholder’s ownership stake if they leave the business. It is important to include a business buy-out clause so all shareholders know what happens if a shareholder leaves the business. This can stop disputes from transpiring between shareholders.
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Structure of a Business Buy-Out Clause
Business buy-out clauses will usually only be activated during certain trigger events. Trigger events could occur when a shareholder:
- retires;
- seeks a divorce with a co-owner;
- passes away; or
- becomes bankrupt.
Common Buy-Out Clause Processes
Right of Refusal
One of the most common buy-out clause processes is one with a right of refusal. This means that other shareholders get the first right to buy the other shareholder’s shares if a trigger event occurs. The other shareholders are not obligated to buy them but have the option to. This is common practice as it allows the business to be kept within the existing owners, which may benefit shareholders.
Business Dissolved
Another buy-out clause process that may be undertaken when a trigger event occurs is the dissolution of the business. This means the business’s assets are sold, all debts are paid, and the shareholders receive any remaining proceeds. This is a standard process if a majority shareholder trigger event occurs or the business cannot be sustained due to a majority shareholder’s departure.
Points to Consider when Dealing with a Business Buy-Out Clauses
Review the Clause Regularly
You must review the clause regularly to ensure you stay up to date with your business’s progress. For example, if the circumstances of your shareholding change, it may not be relevant for your business to have a buy-out clause. Alternatively, the content of your business buy-out clause may change if the structure of your business is altered.
Valuation Methods
You should also consider how you wish to value your business. The value of a business can be challenging to measure accurately, so you must do so in a way that is conducive to all parties. A business’ valuation can differ over time. For example, in a period of high economic growth, your business’s value may be much higher than in an economic recession. Most business buy-out clauses say a business’s value should be measured during the triggering event. The way a business is valued will also differ according to the business. Some businesses will bring in an independent valuer, while others will have a specific valuation method agreed upon between the parties.
Insurance Policies
It is also important to consider insurance policies. A trigger event may be connected to an insurance policy such as life insurance. Therefore, life insurance policies must be integrated into the buy-out clause. For example, if a business partner dies, then part of their life insurance policy may be used towards helping the remaining business partners buy out the deceased business partner’s stake.
Key Takeaways
Business buy-out clauses are essential clauses to include in your contracts. These clauses are usually included in shareholder agreements and outline the procedure when a shareholder leaves the business and what happens to their stake. These clauses are included in shareholder agreements so that shareholders cannot sell their stake to someone who may not have the business’s best interests in mind. A trigger event usually activates business buy-out clauses. This may be when a business partner passes away or if they decide to retire. If a trigger event occurs, the process outlined in the business buy-out clause must be followed.
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Frequently Asked Questions
No, but it is a good idea to include a business buy-out clause to protect shareholders.
Unless there is a process by which it can be circumvented, a business buy-out clause cannot be.
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