Buy-Sell Option Agreements: Key Considerations

What happens to a shareholder’s shares if he or she dies or becomes permanent disabled and cannot continue providing services to the company (Outgoing Shareholder)?

Usually, the remaining shareholders will not want the Outgoing Shareholder’s shares to pass to his or her estate or creditors. This is because they could end up running the company with someone they do not know or see eye to eye with, or even someone with no experience in the particular area of business.

Equally, the Outgoing Shareholder’s estate or creditors may not want the stress of being involved in a company it knows nothing about, particularly after having just lost a loved one.

Shareholders will then resultingly enter into a Buy-Sell Option Agreement, setting out what happens in such a scenario.

Buy-Sell Option Agreements: Key Considerations

There are various provisions that a Buy-Sell Option Agreement contains, including:

1. An obligation on each of the shareholders to take out and maintain insurance in respect of various trigger events. The agreement should set out the type, the insured person and agreed amount of such insurance.
2. Certain trigger events whereby the shareholder must obtain insurance. Generally, death or total permanent disability limits the type of insurance the shareholder requires. But, these can be extended to other events if commercially agreed between the shareholders.
3. A provision that on the occurrence of a trigger event, (i) the Remaining Shareholders can oblige the Outgoing Shareholder to sell its shares to them or (ii) the Outgoing Shareholder can oblige the Remaining Shareholders to purchase its shares.
4. The purchase price at which the shares are to be sold by the Outgoing Shareholder to the Remaining Shareholders. The purchase price is generally fair market value less any insurance proceeds which the Outgoing Shareholder has received (or should have received if it had had the proper insurance in place).

Conclusion

It is both necessary and prudent to consider what happens to an Outgoing Shareholder’s shares if a situation arises which would result in him or her no longer being the shares owner.

The Remaining Shareholders do not want the shares to end up in the hands of someone who has no experience in the business or who does not agree with their business strategy.

Equally the Outgoing Shareholder’s estate may not want the worry and stress of having to be involved in a business it knows nothing about. Accordingly it is important to pre-empt this and put an agreement in place dealing with what will happen to an Outgoing Shareholder’s shares. This agreement should be put in place as early as possible.

If you would like more information on Buy-Sell Option Agreements or you require a Buy-Sell Option Agreement to be  reviewed or drafted, please get in touch with LegalVision today on 1300 544 755. One of our specialist business lawyers would be delighted to assist you!