Shareholders Agreements – Buy-Sell Provision

Whether you are starting a new company, restructuring or reviewing your current company, it is important to consider how your company would cope if one of its shareholders decides to leave, or is otherwise incapable to continue as a shareholder due to reasons such as disagreement, death, illness or mental incapacity. Commonly, when a shareholder has to step down, a company can be confronted with many issues such as valuating the shareholder’s equity interest, deciding whether a new shareholder should enter the business and subsequently finding a suitable third party, deciding whether the interest should be bought by an existing shareholder(s), and how such a change would impact the management and control of the business. A well-considered “buy-sell provision” can address these scenarios before they arise to minimise the impact on the business and its operations.

A buy-sell agreement is a legally binding contract between shareholders and a company, which can provide a nominated purchaser the right to buyout the interest of a departing shareholder or provide a departing shareholder with rules and guidelines relating to the transfer of their equity interest to another person. Sometimes a buy-sell agreement stands alone, however it is often the case that it forms part of the much larger Shareholder Agreement of the company. If you do not have a buy-sell agreement in place, this can put your business at risk and can create conflict among partners, leading to valuable loss of time, costly litigation and increased company expenses.

Effective buy-sell agreements often contain the following:

  1. who has the right to buy a shareholder’s interest
  2. which events an interest can be sold, known as ‘trigger events’
  3. specifies the purchase price of the shares or value of the business
  4. the time frame applied to the sale and purchase of departing shareholder’s interest

In doing so, a buy-sell agreement can balance the needs of an existing shareholder to obtain liquidity at a fair value within a reasonable time frame while still considering the desires of any remaining shareholders to not have their investment objectives, horizon or risk be compromised. They also provide a set process to accommodate the departing shareholder while ensuring the remaining shareholders may retain control of the business without being economically disadvantaged.

Buy-sell provisions can be tailored to the needs of your company, they will often include basic mechanisms such as Right of First Refusal and a Valuation of Shares.

Right of First Refusal

A ‘right of first refusal’ gives the departing shareholder the right to source its own successor to take its place in the company. However, the departing shareholder must first give the company a right of first refusal once a bona-fide offer from a third party is received.

It is important that the replaceable rules, as outlined in the Corporations Act 2001, are first considered. In proprietary companies, there is a statutory pre-emption provision which is set out in section 254D of the Corporations Act 2001. This provision states that before issuing shares, a proprietary company must offer them to existing shareholders and that, as far as practicable, the number of shares offered to each existing shareholder is proportionate to the amount of shares they currently hold.

Under this method the shares will first be offered back to the company, then to the remaining shareholders of the company under the same terms as the third party’s offer. If neither the company nor the remaining shareholders elect to purchase the shares, the shareholder is free to transfer their shares to the third party on the terms of the original offer.

Valuating a Shareholders Interest in the Company

Commonly a dispute may arise in the valuation of the shareholder’s interest in the company. As stated above, the departing shareholder will generally be obliged to offer its interest to the existing shareholders before it may accept an offer from an outside party. Here, shareholders may have a differing opinion on its value. Where the parties, being the departing shareholder and the remaining shareholders and/or the company, cannot come to an agreement on the value of the shares, an independent valuer should be employed to evaluate the businesses financial value. This ensures there is a fair exchange between the departing shareholder and remaining shareholders.

It is important to seek professional assistance before finalising a shareholder agreement. Each shareholder should also seek independent legal advice before entering into an agreement to ensure their interests are being protected.

Do you have questions about Buy-Sell Provisions, rights and obligations as a shareholder, or what Buy-Sell Provisions and a shareholders agreement could do for your business? Please don’t hesitate to contact our experienced Newcastle commercial lawyers at Butlers Business Lawyers on (02) 4929 7002 or fill out an enquiry form on our website.