SHAREHOLDER AGREEMENTS REQUIRE FLEXIBLE BUY-SELL PROVISIONS

There are many reasons why shareholders in closely-held corporationsmay need to quickly sell their shares to others. Therefore, it’s important when drafting a shareholder’s agreement to cover every basic aspect of buying and selling shares – in addition to the general administrative matters that must normally be addressed.
Depending on a corporation’s number of major shareholders and business pursuits, a flexible framework helps facilitate every goal. The following list sets forth some of the main terms that shareholder agreements should cover, separate and apart from the buy-sell provisions that will be discussed in greater detail below.
Common Administrative Topics Set Forth in Many Shareholder Agreements

• Voting rights. Always describe each shareholder’s voting rights and when they can be properly exercised;
• Qualifications for serving as corporate officers. Basic requirements must be stated so that only fully qualified individuals can serve as corporate officers at any level;
• Noncompete provisions. All parties involved with a corporation must agree to avoid compromising its trade secrets or later leaving and then trying to compete for its clients for a limited time;
• Preferred groups to consult with when internal disputes must be resolved. Include the names of specific mediation or dispute resolution services that can be contacted and how the corporation should decide when such outside help is required;
• Inclusion of anti-dilution provisions to protect stock values;
• A description of major shareholders’ “tag-along” rights;
• Registration rights must be explained and how they apply to certain restricted stocks;
• Stock valuation procedures must be described and closely followed.

Once these and other crucial topics have been covered, you and your Houston corporate law attorney should discuss the best buy-sell provisions suited to your corporate structure.
Basic Buy-Sell Provisions – Events That Often Trigger Their Use
Your shareholder’s agreement should always include a very detailed explanation of how shares should be sold when one of the following events takes place.

• The death of a shareholder;
• The termination of an employee shareholder – whether “for cause” or without cause;
• The disability of a shareholder;
• A shareholder’s retirement

When trying to draft the best buy-sell procedures to address these situations, it’s often wise to sit down and review your corporation’s main concerns and interests with your lawyer.
Should the Selling of Shares Be Mandatory — or Provide Parties with Greater Choice?
When trying to answer this question, you may want to provide different answers, depending on whether the sales are to the corporation itself, other shareholders – or to third parties.

1. Should your corporation be given the first right to purchase (or redeem) the stocks? If you and the controlling officers of your corporation wish to include this provision in your shareholder agreement, be sure to first consider the possible capital gains tax issues involved;
2. Do you want to automatically offer the available shares to other general shareholders if the corporation isn’t interested in redeeming the shares after a set deadline? If so, it’s important to indicate if majority shareholders will have the first opportunity to buy the shares;
3. Are you willing to allow outside third parties to buy the newly available shares? If so, you must decide in advance the types of criteria that such buyers must meet.

Other Key Issues Involved with Drafting Your Buy-Sell Provisions

1. Setting the proper price to be paid for the stocks. In general, if the available shares are to be purchased by the corporation or one of its current shareholders, you should have already created a clear formula in your shareholder’s agreement for determining the current, proper valuation of the stock. However, if the shares are to be sold to an outside third party, that outsider’s offer will normally be determined by the current market price for the type of shares involved;
2. How should the price be paid? Most corporations will benefit from establishing a basic buyout procedure within its shareholder agreement so that these common transactions can be handled according in a very clear, pre-determined manner. Since lump-sum payments are usually not preferred, you will need to decide if you prefer such options as:

1. A buyer-financed buyout
2. A seller-financed buyout, or
3. Some type of financing arrangement involving insurance or a trust

Since a corporation’s success is often determined by the terms and quality of its shareholder’s agreement, please feel free to contact our firm so we can provide you with our general legal advice or help you draft a new agreement. 

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