11 March 2024: Buying or Selling PART of a Business
Though many people don’t appreciate its frequency, selling or buying PART of a business is a commonplace event. We’ve held forth on this topic twice in the past (here and here) and, in fact, did a live webinar on this last year. (More on that in a moment.)
But though we’ve discussed buying or selling a portion of a business in some general terms, one of the most important aspects of such an event is one specific document that owners and buyers, especially if the business is small, seem to shrug off or even forget entirely. This document is the shareholders’ or members’ agreement.
A shareholders’ agreement – applicable to an entity formed as a corporation issuing shares – or a members or partners agreement – applicable to entities formed as limited liability companies or partnerships – is an arrangement among shareholders/members/partners that describes how a company should be operated and outlines shareholders’ rights and obligations. Ideally, the agreement would also include information on the management of the company and the privileges and protection of its owners.
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A shareholders’ agreement is intended to ensure that shareholders – the owners of the company – are treated fairly and their rights are protected. The agreement includes sections outlining how to establish share or membership unit value (particularly when sold). It also allows current owners to make decisions about potential future shareholders and provides safeguards for minority positions.
A shareholders’ agreement generally includes what’s referred to as a capitalization table that lists the shareholders and their percentage ownership; any restrictions on transferring shares; pre-emptive rights for current shareholders to purchase shares to maintain ownership percentages (for example, in the event of a new issue); and details on how the proceeds are to be distributed in the event the business is sold.
Shareholder agreements differ from company bylaws. Bylaws work in conjunction with a company’s articles of incorporation (organization documents) to form the legal basis of the business and govern its operations. A shareholder agreement, on the other hand, is often considered optional.
Optional? Really?!?
Though the shareholders agreement may be legally “optional”, it’s absolutely critical whenever a business has more that one owner. We have seen too many examples of partners not getting along, divorces, partner illness or death that, absent a shareholders agreement, throw the business into complete chaos.
How so? Some examples.
One partner wants out for any number of reasons: a disagreement with the direction of the company; a spouse works for an international conglomerate and has just been transferred to Turkmenistan; they won the lottery. How much is that partner’s share of the business worth? Does the business have the right to buy the shares back? (It better!) Do the other owners have the right to buy some or all of the departing owner’s share? How and on what terms is the buyout structured?
If an owner is bringing in a “partner” – someone with the skill set or capital needed to grow the business – how does the new owner “vest”; i.e., does the new partner get all their promised shares at once or over a period of time? What, if any, are the responsibilities of the new partner in the operation of the business?
What if one of the owners believes that the business has reached the point that it should be sold but the other owner(s) want to keep growing the business? What if a buyer shows up out of the blue (as happened to me)? If an exit target or succession plan has not been established, this is an issue that can cause enormous conflict.
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Courses! Courses! Courses!
Many of you have asked if our Flagship Course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, could be made available on a module-by-module basis. Instead of enrolling in the complete course, could you enroll only in the module(s) you wanted? We’re happy to report that this is now possible.
We’ve broken our Flagship into six separate modules (or module groups) to give you all the flexibility you need to learn only what you want to learn – and we’ve moved them all over to the new Brokers Academy in The Brokers Roundtable℠ . The Flagship is still available but the modules are now available individually.
You don’t need to be a Member of The Brokers Roundtable℠ to access any of these courses but if you are, you’ll receive a 20% discount on any course you enroll in. If you’re not yet a member of The Brokers Roundtable℠, you can learn more – and get access to all the talent and resources – here.
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What’s In It?
The main purpose of a shareholders or membership agreement is to establish an understanding among the owners of a business as to how that business will be operated. But it should also be structured so that if any one of dozens of unforeseeable (but potential) events occurs, there is a roadmap that can guide the owners through any unexpected crisis and avoid, to the extent possible, the discord and turmoil that would otherwise unfold – and damage the business in the process.
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Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
If you’re a business owner considering taking on a partner or if you have the opportunity to acquire a portion of a business that needs your talent, a shareholder agreement is a must. Such an agreement should have, at minimum, the following topics clearly covered – spelled out in depth and detail:
- Voting rights. Who can vote when decisions must be made? If a new owner comes on board and owns 25% of the company, is their ownership worth 25% of decision-making power or is it worth more – or less? Is their ownership position – 25% – reflective of their capital or talent infusion? If the latter, the weight of their vote might be higher than their 25% of equity.
- Roles and responsibilities. These must be clearly spelled out to avoid any confusion or discord. This is often a point of tension among owners. Get this described as clearly as possible.
- Dispute resolution. Disputes arise. How are they resolved?
- Profit distribution. How are the parties paid or profits split?
- Non-compete. If one owner wants out (see next two point), you want to make sure that he/she won’t immediately establish a competing company or join an existing competitor.
- Succession plan. What happens in the event of an owner’s death or disability? When we’re starting or growing a business in our 30s, we rarely think about the inevitable end of life. Even when we do, we probably imagine it many, many years in the future. But at this point in my own life, given what I’ve experienced, I’m a firm believer in the “random truck theory of like”. I imagine that each of you reading this, know what I mean.
- Exit strategy. You may think it ludicrous to plan for your eventual exit but it WILL come. Our tagline is, “Every Business That Doesn’t Fail Will Sell…Every One!” That includes yours. If you don’t have a destination, you’ll never now where you are in relation to it.
The Bottom Line
Shareholder or membership agreements can help business owners avoid countless pitfalls and conflicts. They can also assure that everybody involved is rowing the boat in the same direction.
We can’t over-estimate the importance of a shareholders or membership agreement for a business – no matter how small – that has more than one owner. We’ve seen too many battles between owners as a result of operational disagreements, personal divorces, arguments about money, one owner wanting to hire their kid, etc., etc.
We’ve worked with companies with multiple owners where one owner dies suddenly. Without a shareholders agreement, the deceased owner’s heirs now become owners. Imagine going from four owners, to three (after the dealt) to 15 with the heirs – none of whom know anything about business and some of who may be under age 6!
We offer a package of white label forms in the Resources section of The Brokers Roundtable℠. An attorney that specializes in small business can also prepare one. (There is a business attorney-member of The Brokers Roundtable℠ – Jim Wilson – who can help with most legal and organizational aspects of small businesses.)
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at jo*@Wo*******************.com