Negotiating Shareholder Agreements: What You Need to Know

By: Henry Hutcheson

From: IGC Retailer, March/April, 2013

Negotiating Shareholder Agreements: What You Need to Know
When it comes to making decisions for your garden center, the overriding issue is who gets the most say in answering questions that arise. We all think the person with the most ownership should, since the majority owner has greater control and more say than the minority shareholders. However, in the case of multiple shareholders with equal share portions, the group needs to come together as a majority to determine control of the garden center.

Consider putting into place a shareholder agreement - “an arrangement among a company’s shareholders describing how the company should be operated and the shareholders’ rights and obligations,” as described by Investopedia. It not only outlines the parameters of operations and the rights of shareholders, it also includes information on the regulation of the shareholders’ relationship, the management of the company, ownership of shares and the privileges and protection of shareholders. It helps ensure shareholders are treated fairly and their rights are protected. The agreement outlines the fair and legitimate pricing of shares, particularly when sold. It also allows shareholders to decide what outside parties may become future shareholders, and provides safeguards for minority positions.

Buy-Sell Agreements
One of the main components to any shareholder agreement is the buy-sell agreement. A buy-sell agreement is a contract between the co-owners of the garden center to buy or sell their respective interests in the business under certain situations, such as the death or retirement of an owner or simply the desire to cash out. The pricing and payment methodology is also usually spelled out.

While this may seem straightforward, that’s not always the case. And it can get even messier in a family business. With a family business that has been passed down through multiple generations, there can be radically differing interests and backgrounds.

I had a second-generation family business client where there were three brothers running the business. There was a significant difference of opinion among the oldest brother and the middle brother on the definition of work - the oldest had a more puritan work ethic, while the middle one’s view was “bohemian.” Needless to say, the middle brother was pushed out. While they’re brothers and do love each other, working through the details of what constituted “fair” in terms of a buy-out was awkward and uncomfortable.

The older one, who was the president and was tiring, had fewer financial obligations. The youngest one was eight years his junior, not the president but a diligent worker and married.
Once the middle brother departed, the two remaining brothers decided to put an agreement in place to guard against any unforeseen eventualities. And so the shareholder agreement and buy-sell agreement came into play.

Key Questions to Ask
The first reaction in considering a shareholder agreement is to engage with an attorney, but the true first step is to engage in multiple discussions, over time, about what can be referred to as the “touchy-feely” issues. The parties in the agreement need to understand the personal and professional goals of each of the family members.

The ultimate goal is that - with a truly comprehensive understanding of each other’s situation, whether you agree with it or not - everyone can move forward together. There also needs to be a good comprehension of the intrinsic financial life of the garden center as it passes from one generation to the next.

Some key considerations that always need to be negotiated when it comes to a shareholder agreement or buy-sell in a family business:

1) Do you need to work at the garden center to own shares of the company? While this keeps control in the hands of those who know the company best, there may be insufficient liquidity to buy out those who leave.

2) Do you want to be in business with your in-laws? What if they know nothing about the business?

3) How do you value the company? It can be valued by a certified valuation professional at the time of an event, or you can agree on book value for the sake of the business.

4) Where will the money come from for a buy-out? In the case of a death, life insurance. Predetermine a plan that will not materially damage the company if someone decides they want to leave and needs the money, which is usually a payout over multiple years.

Remember, the important thing in figuring out how to negotiate a shareholder agreement or a buy-sell is establishing them before you ever need them.

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