Ownership Control and Buy-Sell Agreements

By: Anthony L. Barthel

What is an “Ownership Control” or “Buy-Sell Agreement”?

An Ownership Control Agreement, Member Control Agreement or Shareholder Control Agreement are different names for a very similar document addressing the control and governance of a company. These Agreements are different than Operating Agreements or Bylaws that typically address procedures for calling meetings and votes of owners and executives. Rather, these types of Agreements provide for more specific requirements for certain company actions, such as the manner of distributions, voting requirements for certain company action and in some cases an allocation of profits and losses different from statutory norms. Often, these Agreements are coupled with a Buy-Sell Agreement that addresses the valuation and transition of ownership of the company in certain events such as death, disability, divorce, bankruptcy or termination of an owners’ employment or association with the company.

Why have these types of Agreements?

Similar to most agreements, an Ownership Agreement contains predetermined outcomes in order to provide certainty to a company and its owners. For example, at a certain point in the company’s existence the owners may determine that certain procedures are to be followed in the event another business offers to purchase the company’s assets, or in some cases, some ownership interest in the company. These Agreements can dictate the timing of such an acquisition, and can repel certain advances while inviting others. If the majority owners are interested in a quick disposition of the company terms may be drafted to facilitate a timely vote by the other owners. Likewise, if the minority owners want to preserve certain rights related to their ownership, they may bargain for terms provoking dialogue among the owners and the company’s management.

For many small business owners, these Agreements contemplate an “exit strategy” or a “continuity strategy” to ensure the business’ ongoing vitality. By creating options for purchase by the company or other owners upon certain events, the remaining owners can protect the integrity of ownership while providing a departing owner with adequate compensation. Without these types of Agreements, it is often difficult, if not impossible to plan for the future

Is there a way to invest in my company’s ownership exit strategy now?

Many financial products are available to owners desiring an exit strategy. Most commonly, life insurance policies or disability policies can be purchased by individuals or the company in order to buy-out a disabled or deceased owner’s interest in the company. Performed correctly, the company can realize a tremendous advantage in these scenarios. However, financial products purchased without a well crafted Agreement may only intensify a contentious situation. It is impossible to go back into time – address these scenarios now. Many a business owner has expressed sincere frustration and regret in dealing with a deceased owners’ estate, rather than with their business partner. Just like a well crafted estate plan, these Agreements express the desires of owners that their family or legal guardians may never have been aware of or appreciated.

Are Ownership Control or Buy-Sell Agreements specialized by industry?

While many corporate law principles apply to all companies, industry specific Agreements can be extremely helpful. For example, many Agreements have a predetermined formula or procedure for determining the value of ownership interests – application of the wrong valuation can severely damage one party, while creating a windfall for another. In other situations, it may be useful to provide for an option to purchase an active owners’ interests in the company upon retirement, while not providing an option for a passive owners’ interest. The purchase of an active owners’ interest may free equity in the company that can be used to attract and retain key management personnel in certain businesses. For service industries, these types of Agreements can be used to limit certain owners’ expectations on lifetime or continued employment and can bar certain claims exposing the company to unnecessary liability.

My company already has an Ownership Agreement. Do I need to do anything else?

Companies can change rapidly. Any company experiencing substantial change in its management or revenues should consider reviewing their Ownership Agreement as a business planning tool. Fluctuations in a company’s business give rise to the need to address the manner in which it is valued for buy-sell purposes. For example, many Ownership Agreements contemplate an annual valuation by the company’s owners. Failures to update annual valuations of the company create unintended litigious opportunities. Owners of the company should not become complacent and should exercise the discipline of reviewing issues posed by their Ownership Agreements on an annual basis.