Monday, May 9, 2011

S-Corporations: What are they and why care? - Part 3

Part 3 - Transfer Restrictions - Buy-Sell Agreements

Typical for any S-corporation, C-corporation, limited liability company, or partnership, owned by more than one person, are certain provisions that govern who can be an owner and under what circumstances. For example, although your partner and you chose to work together, in the event of the death of one of the other owners, many business owners would not chose to work with the decedent-owner's inheritors. For this reason, legal restrictions called buy-sell provisions are typical in owner agreements. Partnership agreements are the easiest example, since there is broad discretion to restrict transfers, either voluntary or involuntary.

The shares of a corporation may be restricted for any reasonable purpose as long as it is not unconscionable. However, the type of restrictions are limited in their remedies to (1) obligate the shareholder first to offer the shares to the corporation or other persons; (2) obligate the corporation or other persons to acquire the shares; (3) require consent to the assignment if not manifestly unreasonable; (4) prohibit transfer to designated persons or classes of persons, if not manifestly unreasonable; or (5) contain any other provision reasonably related to an authorized purpose. In contrast, a LLC membership interest is freely assignable except as provided in the articles of organization or a written operating agreement. The assignee only becomes a member of the LLC if the other members unanimously agree or if the articles of organization or operating agreement otherwise provide.

A buy-sell agreement or provisions, whether it is contained in a shareholders agreement or operating agreement, provides transfer restrictions if a triggering event occurs. These triggering events typically include the death of an owner, the firing of an employee-owner, the retirement or disability of an owner, or the attempted sale or transfer by an owner. These buy-sell provisions often require the triggering event owner to sell to the remaining owners or the company itself at a set price or a price deduced by an accountant or using a formula. Typical valuation formulas for small or large companies include (1) books value, (2) some factor or multiple of gross or net revenue, or (3) liquidation values.

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