What is an Equity Buyout Agreement?
Equity buyout agreements are legal contracts used in situations where an owner or investor sells his or her share of an enterprise to another shareholder or to the company itself. The ownership interest can be public or private, and the transfer can involve one or more owners. Equity buyout agreements can arise in many different business contexts, including transferring ownership in a business from an owner to a family member, buyouts when shareholders leave an enterprise due to retirement or divorce, or the sale of the entire business.
These agreements can be either general or individualized to specific situations . They can also pertain to buyouts between co-owners or can involve other businesses or non-owners.
There are a wide variety of situations in which these contracts and buyouts are important. An equity buyout agreement can be particularly significant as part of a shareholder agreement, in which two or more shareholders require that a controlling shareholder buy out his or her ownership interest if he or she decides to leave or dies, shares are divided among the remaining owners, with those who remain getting an additional payout for being bought out.
These buyout agreements can be especially useful in protecting the interests associated with a company’s buy-sell agreements and shareholder agreements.
Elements of an Equity Buyout Agreement
An equity buyout agreement serves as the blueprint for a smooth transaction when partners or minority interest owners decide to part ways. Essential components of an equity buyout agreement include:
Terms of the Buyout: Circumstances under which the buyout is triggered may include a retirement, termination of employment, disability, death, dissolution, divorce settlement, or a third-party purchase. Your equity buyout agreement should contain the conditions upon which a partner or minority owner can be bought out or may buy out; giving the company the ability to force a buyout may not be in the partner or minority interest owner’s best interest. The agreement should also outline the buyout process, what obligations, if any survive, and return of a capital account.
Valuation Method: All parties must be in agreement of the method of valuing the equity ownership interest. Valuation methods may include book value, liquidation value, market value, capitalization of earnings, price/earnings multiple, asset-based valuation, and discounted cash flow. The valuation method will determine the value of the ownership interest when it is being bought out.
Payment Terms: The payment terms must be clearly defined in the equity buyout agreement, specifying how the cash will be paid. Will the buyout occur in one transaction or in installments? Must the payments be made in cash or can they be other forms of currency such as stock in the company? Will interest be charged on the amount due and if so, what is the interest rate? Parties need to consider tax implications and what would happen in the event of default.
Contingencies: The equity buyout agreement should outline how the company will handle unanticipated situations such as the death of a principal, loss of a key contract, divorce settlement, or change in law, which could affect value. Fall-out contingencies for all parties should also be included in the equity buyout agreement.
How to Create a Template for an Equity Buyout Agreement
The first step in creating an equity buyout agreement template is to identify the specific needs and structure of your business. Not all companies are the same, and the requirements for an equity buyout agreement will vary based on a variety of factors, such as the number of business owners, the ownership structure, the state where the business is located, and the industry in which the business operates.
After gathering information on the specific needs and structure of your business, the next step is to determine if the internal parties that own the business have already agreed to or otherwise put into place the procedures and conditions under which an equity buyout is permitted. If the company is a corporation or a limited liability company, its bylaws and operating agreements can provide this information. In addition, any buy sell agreement that has already been put in place should also be reviewed.
Once you have obtained all relevant information regarding the business’s current equity buyout policies and procedures, the next step is to draft a template that can be used in connection with any future purchases of equity from a departing or deceased owner. This template should take into consideration your company’s bylaws, operating agreement and any existing buy-sell agreement, as well as the specific needs and structure of your business.
It is important to remember that an equity buyout agreement template is just that, a template. Each equity buyout will be unique based on the individual circumstances of the seller and the relevant business considerations. The purpose of an equity buyout agreement template is to become familiar with and understand the various issues that are to be contemplated and controlled in the equity buyout agreement so that, at the time of any request to purchase ownership interest from an existing owner, the document can simply be customized to fit the particular situation with minimal time and effort.
Avoiding Common Mistakes
When creating an effective equity buyout agreement template, businesses should steer clear of a few common pitfalls in order to maximize the utility of the document. The first mistake is not clearly defining the circumstances under which a buyout would occur. Without a clear delineation of situations in which the company can acquire an individual’s shares, the agreement is too vague to be particularly useful. Next, many businesses fail to establish a framework for resolving differences. Even when circumstances of a buyout are clearly defined, there are still instances in which disagreements can arise. The absence of a clear method for resolving such differences can lead to protracted and expensive legal disputes. Finally, some businesses neglect to detail the process of determining the current value of shares. Not only is this process important to ensure a fair price at the point of buyout, but also to ensure that all current shareholders are aware of the current value of their shares. The best way to avoid these pitfalls is to carefully review and, if necessary, consult with a lawyer. By being diligent in drafting the buyout agreement template, it is likely that you will save money in the long run by avoiding expensive legal disputes.
Legal Considerations
When drafting an equity buyout agreement, there are a number of important legal considerations that must be taken into account. First and foremost, the agreement must comply with all relevant laws and regulations, including federal and state securities laws, tax laws, and employment laws. Failure to comply with these laws can result in significant legal and financial consequences for both the company and the departing employee.
In addition, the agreement must be carefully tailored to the specific circumstances of the company and the individual involved. This means taking into account the company’s size and structure , the nature of the employee’s role and contributions to the company, and any unique circumstances related to the specific buyout. A poorly drafted agreement that does not adequately address these factors can lead to disputes and liability down the road.
It is important to work with experienced legal counsel when drafting an equity buyout agreement to ensure that it meets all legal requirements and adequately addresses the interests of all parties involved.
Advantages of Using a Template
Benefit of a Template
An equity buyout agreement template provides immediate advantages. With a template in hand, you’ll be able to draft the necessary provisions without needing to spend much time figuring out what is required for each provision. This save considerable time at both the drafting stage and again later on if an issue arises regarding a provision. Having a template will result in the following benefits:
Save Time: It’s always easier to work with similar language that has already been vetted by competent legal counsel than it is to draft something from scratch to get a similar or identical result. A template can offer a quicker way to produce a comprehensive document.
Ensure Consistency: Equally important is that your agreements mirror each other in form and content. Otherwise, you may be doing unequal treatment to both parties because of the differences between the two agreements.
Cover All the Bases: It’s generally possible to cover all bases when using a template. That’s because a template will usually contain language to cover every scenario that currently exists or is likely to arise in the future. If the buyout provision you require relies on a number of different elements, you can rest assured that the template will have them all.
Give Legal Validation: If all parties know that the provisions in question have been vetted by legal counsel, it adds the credibility and validity that the parties might need during a potential dispute.
How to Customize Your Agreement
Customizing your equity buyout agreement template appropriately can be the difference between an agreement that smoothly facilitates a buyout process and one that will potentially lead to future legal problems. When customizing your buyout agreement template, keep the following tips in mind: Make it fit your business cycle. Because the business cycle makes a difference in how a buyout is negotiated and finalized, you need to adjust your buyout agreement template to align with your particular business cycle. For example, a business that is just starting out may not even have any financial records, while you want to wait until the second quarter of the year to buy out a key employee who was recently laid off . Factor in current circumstances. Any major events that occur within a business can be accounted for in the buyout agreement template and subsequent negotiation. If a key investor recently decided to divest their equity holdings, or the business is on the verge of receiving a major contract, those events should be factored into the negotiation and the agreement. Consult an attorney for assistance. A lawyer with experience in the nuances of buyout agreement negotiations can best advise you on effective wording and clauses for your buyout agreement template. They can also help you negotiate with any employees and strategize a buyout negotiation for maximum effectiveness.