Use this checklist when drafting your Minnesota Buy-Sell Agreement. If you want to schedule an Initial Minnesota Buy-Sell Legal Consultation with Trepanier MacGillis Battina P.A. law firm, complete this checklist prior to your attorney consultation but please do not send it to the firm unless requested by an attorney.
This checklist assumes that your legal entity is either a corporation or limited liability company. For simplicity, sometimes terms such as “shares” and “membership units” are used interchangeably. Likewise, the terms “shareholder” and”member” are used interchangeably. The term “owner” refers to any form of owner, regardless of the type of legal entity in question.
1. Information and Documents: If you have already registered your corporation, limited liability company (LLC), or other legal entity, you should obtain copies of the following documents (if they exist) in connection with preparing your Buy-Sell Agreement. These documents will be needed by the attorney who prepares your Buy-Sell Agreement:
(a) Articles of Incorporation / Articles of Organization
(b) First Set of Minutes of the Incorporator / First Set of Minutes of Organizer
(c) First Set of Minutes of the Board of Directors and Shareholders
(d) Bylaws / Operating Agreement
(e) Shareholder’s Agreement / Member Control Agreement
(f) Subscription Agreement for Shares / Contribution Agreement(s) for Membership Units
(g) Share Ledger / Membership Unit Certificate Ledger
(h) Share Certificates / Membership Unit Certificates
(i) Stock Option Plans / Stock Option Grants
(j) Employee Stock Ownership Plan
(k) All other corporate resolutions, minutes, or agreements
(l) Your “corporate minute book”
2. Identity of Owners and Percentages: You should identify each owner by name, address, home phone number, daytime phone number, fax number, e-mail address, dates shares were issued, stock certificate number, number of shares, and the amount paid as a capital contribution for the shares (or other form of consideration such as property, equipment, intellectual property, or services rendered):
| Name: | |
| Address: | |
| Home Phone Number: | |
| Daytime Phone Number: | |
| Fax Number: | |
| E-Mail Address: | |
| Date of Issuance: | |
| Stock Certificate Number: | |
| Number of Shares: | |
| Amount Paid (or other Consideration): |
Vesting Schedule for Additional Stock: You should identify and describe any vesting schedule for additional transfers of stock or membership units (either by agreement or as anticipated by the company).
Stock Options: You should state whether the company has issued any stock options, stock grants, or adopted any type of stock option or stock grant plan. If so, provide copies of the same to the attorney who prepares your Buy-Sell Agreement.
Former Shareholders: Has the company “bought out” former shareholders in the past? If yes, provide copies of the legal and transactional documents surrounding the buy-out to the attorney who prepares your Buy-Sell Agreement. In addition, describe the valuation formula the company used and the purchase price per share / membership unit.
Key Agreements between Owners:Describe all formal or informal agreements and understandings (whether written or verbal) between the owners regarding buy-sell issues. Attach a copy of any written agreements or drafts.
7. Life Insurance: Describe any life insurance policies purchased by the company or the shareholders on the lives of the shareholders.8. Transfer Restrictions: In a closely held business owned by a small number of shareholders, the owners usually prefer to limit the transfer of shares to outsiders. If no transfer restrictions have been agreed to in writing, the remaining owner(s) will typically have little or no control over who the new co-owners might be. Often, a Buy-Sell Agreement provides that, upon the occurrence of certain events, a departing owner (or that owner’s estate) must offer to sell his or her shares back to the corporation or the remaining owner(s). In conjunction, the agreement can require that the company (or the remaining owners) must buy the departing owner’s share of the business, or it can simply provide the company (or the remaining owners) with an option to buy the shares. The events that trigger the buyout provisions of the agreement can include an owner’s acceptance of an outside offer for his or her share of the business, death, disability, resignation of employment, or termination of employment. For the following scenarios, identify the preferred treatment of shares.
(a) Termination of Employment Without Cause:
Nothing: Owner may keep the shares and there is no obligation to buy/sell.
Forced sale: Company obligated to buy / shareholder obligated to sell.
Company Option: Company has the option (but not obligation) to buy. Typically this is coupled with a provision stating that the option to buy reverts to the remaining shareholders if the company does not exercise the option.
Shareholder “Put” Option: Shareholder can force the company to buy / company cannot force the shareholder to sell.
(b) Termination of Employment With Cause:
Nothing: Owner may keep the shares and there is no obligation to buy/sell.
Forced sale: Company obligated to buy / shareholder obligated to sell.
Company Option: Company has the option (but not obligation) to buy. Typically this is coupled with a provision stating that the option to buy reverts to the remaining shareholders if the company does not exercise the option.
Shareholder “Put” Option: Shareholder can force the company to buy / company cannot force the shareholder to sell.
(c) Resignation of Employment:
Nothing: Owner may keep the shares and there is no obligation to buy/sell.
Forced sale: Company obligated to buy / shareholder obligated to sell.
Company Option: Company has the option (but not obligation) to buy. Typically this is coupled with a provision stating that the option to buy reverts to the remaining shareholders if the company does not exercise the option.
Shareholder “Put” Option: Shareholder can force the company to buy / company cannot force the shareholder to sell.
(d) Disability:
Nothing: Owner may keep the shares and there is no obligation to buy/sell.
Forced sale: Company obligated to buy / shareholder obligated to sell.
Company Option: Company has the option (but not obligation) to buy. Typically this is coupled with a provision stating that the option to buy reverts to the remaining shareholders if the company does not exercise the option.
Shareholder “Put” Option: Shareholder can force the company to buy / company cannot force the shareholder to sell.
(e) Death:
Nothing: Owner may keep the shares and there is no obligation to buy/sell.
Forced sale: Company obligated to buy / shareholder obligated to sell.
Company Option: Company has the option (but not obligation) to buy. Typically this is coupled with a provision stating that the option to buy reverts to the remaining shareholders if the company does not exercise the option.
Shareholder “Put” Option: Shareholder can force the company to buy / company cannot force the shareholder to sell.
(f) Divorce, Bankruptcy, or Other Involuntary Transfer: Normally, the Buy-Sell Agreement will provide that in the event of an involuntary transfer (or purported transfer) of shares upon divorce, bankruptcy, receivership, or in other situations, the company can buy back the shares pursuant to the Buy-Sell Agreement. Keep in mind that applicable law might allow the involuntary transfer notwithstanding limitations in the Buy-Sell Agreement, although the ability to restrict the transfer of shares will be heightened with such provisions.
(g) Offer from Third Party: Usually, the Buy-Sell Agreement will provide an “option” or “right of first refusal” to the company to match any from a third party to purchase an owner’s shares. The owner typically must disclose the details of the third party’s offer and the company will then have a designated period of time to match the offer. If the company does not exercise its option, the right of first refusal can lapse (expire) or revert to the remaining shareholders. Indicate your preference for handling third party offers:
No restrictions: Owner can sell to third parties without restriction.
Company Right of First Refusal: Company has the option (but not obligation) to match the offer. Typically this is coupled with a provision stating that the right of first refusal reverts to the remaining shareholders if the company does not exercise the option.
- Valuation Formula: The Buy-Sell Agreement must specify how the selling price of the departing owner’s shares will be determined. There are several methods that can be used to determine the selling price. Some of the most common methods are described below. You should indicate which valuation method seems most appropriate for your business (to be discussed in further detail with the attorney):
(a) Agreed Value: One method is for the shareholders to agree upon an initial price per share that is subject to periodic review by the owners. This is called the “agreed value.” If the agreed upon value is stale (for example, more than 12 months old), then the company and the departing shareholder can attempt to negotiate over the price upon a triggering event. If no agreement on price can be reached, then the Buy-Sell Agreement can call for one of the other methods described below. The benefit of starting with an “agreed value” is to avoid the significant expense of third-party appraisals that are sometimes necessary under other valuation methods.
Do you want to include an “agreed value”? Yes No
What is the “agreed value” as of the effective date? $_________________
How long should the “agreed value” be effective before an appraisal must be conducted? _____ months
If the “agreed value” is stale (more than the number of months listed above), what other method will be used?
Book Value?Multiple of Earnings?
Multiple of EBITDA?
Fair Market Value?
(b) Book Value: This method determines the “book value” of the corporation’s assets for tax purposes and then divides that value by the number of outstanding shares to determine a price per share. Choosing “book value” often yields a price significantly less than would exist had a different valuation formula been used. Book value does not include intangible value (such as customer goodwill or intellectual property) and does not reflect the future earning potential of the business. It simply measures the current value of assets for tax purposes.
Do you want to use “book value”? Yes No
As of the date you complete this checklist, what is the estimated “book value” of the corporation? $____________
(c) Multiple of Earnings: This method uses a multiple of annual profits / earnings of the corporation to determine its value. There are variations on a theme, but this method essentially determines the average profits of the corporation over a designated period of time (e.g., the last five years) and then multiplies that figure by some agreed upon number (e.g., three) to determine the value of the corporation. That number is then divided by the number of outstanding shares to determine a price per share. The logic is that a potential buyer would be willing to purchase the company for a “multiple” of yearly earnings.
Do you want to use a “multiple of earnings” formula”? Yes No
How many years has the corporation been in business? _______ years
Do you want to utilize an average “net income” by looking backwards for a period of years? Yes No
If so, how many years back do you wish to look? _______ years
What “multiplier” should be used to determine the corporation’s value? _________ (e.g., “three (3)” or “five (5)”)
(d) Multiple of EBITDA (“Earnings Before Interest, Taxes, Depreciation and Amortization”): This method is simply an example of the method described above (“Multiple of Earnings”) that uses EBITDA to determine the corporation’s net earnings. EBITDA is an accounting concept that measures the corporation’s net income with interest, taxes, depreciation, and amortization added back to it. Once EBITDA is calculated, typically a “multiplier” is used (as described above) to determine the overall value of the corporation. Again, this method is attempting to approximate what a hypothetical buyer might be willing to pay for the corporation.
Do you want to use a “multiple of EBITDA” formula”? Yes No
How many years has the corporation been in business? _______ years
Do you want to utilize an average “EBITDA” by looking backwards for a period of years? Yes No
If so, how many years back do you wish to look? _______ years
What “multiplier” should be used to determine the corporation’s value? _________ (e.g., “three (3)” or “five (5)”)
(e) Fair Market Value: This method is a flexible method that essentially asks a third party appraiser to determine “Fair Market Value” based on commonly accepted financial indicators and variables. Typically the following factors are considered:
- The nature of the Company’s business and the history of the enterprise from its inception;
- The economic outlook in general and the condition and outlook of the specific industry in which Company operates in particular;
- The book value of the Company’s stock and financial condition of the Company’s business;
- The earning capacity of the Company;
- The dividend-paying capacity of the Company;
- The Company’s historical and projected revenues;
- The Company’s historical and projected operating expenses;
- All cash on hand, retained earnings, and accounts receivable of the Company (to the extent they are deemed collectible);
- The goodwill, intellectual property, and/or other intangible value of the Company (if any);
- The market value of all tangible assets owned by the Company (such as equipment, machinery, computers, and supplies);
- The market price of stocks of companies engaged in the same or similar line of business as the Company having their stocks traded in a free and open market;
- The fair market value, if ascertainable, of companies of a similar size engaged in the same or similar line of business as the Company, that have been bought and sold within a time period sufficiently close in time to the date of valuation; and
- Any documented purchases of, or offers to purchase, the Company’s stock from independent third parties within a time period sufficiently close in time to the date of valuation.
Do you want to use a “Fair Market Value” formula”? Yes No
Do you want to consider all of the factors listed above? Yes No
Do you want to consider any other factors? Yes No
If so, list the other factors you want considered: ______________________________________________
10. Fair Market Value Discounts: If you have chosen “Fair Market Value” as the valuation formula to be contained in the Buy-Sell Agreement, you should decide whether the appraiser will apply the following “discounts” when determining the value of the shares:
(a) Minority Discount? You should indicate whether a “minority discount” will be applied. A minority discount reduces the value per share where less than a controlling interest of the company is being sold, under the theory that an arms-length buyer in the marketplace would not be willing to pay as much for a small percentage of shares as they would for a controlling interest (51% or more). If you instruct the appraiser to apply a minority discount, this will generally work to the detriment of shareholders who hold a small number of shares.
Do you want a “minority discount” to apply? Yes No
(b) Lack of Marketability Discount? You should indicate whether a “lack of marketability discount” will be applied. A lack of marketability discount takes into consideration the fact that because there is no ready and open market for shares of a closely-held small business, the value per share will typically be less than if such an open market existed. For example, it is much easier to sell shares in a publicly traded corporation than in a small business. Hence, publicly traded shares will tend to be valued somewhat more than shares in a privately held corporation because the shares are deemed more liquid and can be sold more quickly if the owner wishes to generate cash.
Do you want a “lack of marketability discount” to apply? Yes No
(c) Key Person Discount? You should indicate whether a “key person discount” will be applied. A key person discount takes into consideration whether the success of the business depends greatly on one or a handful of key individuals. If those people resign, become disabled, or die, the business could be devastated. As such, a business that is dependent upon a key person is typically worth less than a business that can succeed whether or not any particular individual stays with the company.
Do you want a “key person discount” to apply? Yes No
11. Appraisal Procedure: Under virtually all of the valuation methods described above, other than “Agreed Value,” if the corporation and the shareholder cannot agree upon the valuation price, the Buy-Sell Agreement will call for a neutral third party appraisal to determine the price. The appraiser will be directed to apply the formula set forth in the Buy-Sell Agreement. Even when the Buy-Sell Agreement utilizes an “Agreed Value,” a third party appraisal is typically required if the agreed upon price is more than twelve (12) months old. The parties can waive the right to an appraisal if they are able to negotiate a mutually agreeable price.
12. Valuation Upon Death: In general, the value of a deceased owner’s share of the business will be included in that owner’s estate for estate tax purposes. Therefore, it is very important to seek advice from an accountant before agreeing to any valuation formula. The Buy-Sell Agreement should be structured in such a way that the selling price of the deceased owner’s share is respected by the IRS, or estate tax liability could exceed any amount actually received by the deceased owner’s estate under the Buy-Sell Agreement. Historically, the value of the shares under a Buy-Sell Agreement will be respected by the IRS for estate tax purposes if four criteria are met.
- First, the value of the shares must either be fixed or determinable based on the valuation formula contained in the Buy-Sell Agreement.
- Second, the deceased shareholder’s estate must be obligated to sell at death at the fixed price.
- Third, a transfer restriction must apply during the deceased owner’s lifetime. Generally, this means that before a shareholder can sell the shares during his/her lifetime, the Buy-Sell Agreement must (at a minimum) require the shareholder to grant an option to the corporation or the other shareholders to purchase the shares at the fixed or determinable price.
- Fourth, the agreement must be a bona fide business arrangement and not a device to pass the interest to the natural objects of the deceased owner’s bounty without full and adequate consideration. Generally, this requirement is satisfied if the price under the Buy-Sell Agreement is equal to the fair market value of the interest at the time the Buy-Sell Agreement is executed.
You should indicate whether you want the formula contained in the Buy-Sell Agreement to control for IRS estate tax purposes. If so, you should obtain the opinion of an accountant as to whether this goal is accomplished by the draft language before the Buy-Sell Agreement is signed by the shareholders. Keep in mind that, in order for the buy-sell price to control for estate tax purposes, the shareholders must agree to transfer restrictions during lifetime. This may not be desirable for someone who expects to sell their shares to outsiders.
Do you want the Buy-Sell Valuation Formula to control for IRS estate tax purposes? Yes No
Will you obtain an opinion from your accountant that your estate tax goals are met before signing? Yes No
13. Payment of Purchase Price: The Buy-Sell Agreement should address how the buyout of a departing shareholder will be funded in order to prevent the cost from becoming unduly burdensome on the continued operation of the business. Typically, a percentage of the purchase price is paid at closing, with the balance paid over a period of time as set forth in a promissory note. Set your schedule below:
Lump sum at closing: _________%
First anniversary of closing: _________%
Second anniversary of closing: _________%
Third anniversary of closing: _________%
Fourth anniversary of closing: _________%
Fifth anniversary of closing: _________%
- Pledge of Shares:Typically, the departing owner will require the company to pledge the shares of stock as security (collateral) to ensure receipt of any installment payments called for under the Buy-Sell Agreement. While the payment plan is being honored, the departing owner will not have any rights to vote the stock or otherwise. However, if the corporation defaults in the payment plan set forth in the promissory note, the departing shareholder under this scenario would be treated as a secured creditor with the right to seize the shares. Indicate below whether you want to include a “pledge of shares” provision.
Do you want to include a “pledge of shares” provision? Yes No
15. Life Insurance: Life insurance is a common method of funding a buyout under a Buy-Sell Agreement triggered by an owner’s death. The deceased shareholder will want assurance that the business will have enough cash to fund the buy-out so as to protect his or her family or other beneficiaries who are to receive the purchase price upon his/her death. The corporation will want a mechanism for funding the buy-out during the disruptive period following the shareholder’s death. Life insurance is an obvious funding mechanism. It is recommended that you discuss life insurance issues with a qualified insurance advisor or financial planner and your accountant. There are important tax and estate planning considerations that will be impacted by whether the life insurance premiums are paid by the company or the individual shareholders. Depending on the type of entity (C-Corporation, S-Corporation, LLC, etc.), the cost of the premiums might not be deductible to the entity for income tax purposes. Further, you should decide whether the premiums will be funded with “after tax” dollars, in which case the death benefit might not be taxable. Finally, you should decide whether the corporation will purchase the life insurance policies, or whether the individual shareholders will “cross purchase” policies of life insurance on the other owner(s).
Do you want to utilize life insurance to help fund the Buy-Sell Agreement price upon death? Yes No
Who do you want to own the life insurance policy? Corporation Cross-Purchase by Each Shareholder
Name of Your Accountant: _____________________________ Phone Number: ___________________________
Name of Your Insurance Agent: _________________________ Phone Number: ___________________________
- Sale of Business Issues: Although sometimes handled in a separate document called a “shareholder agreement,” the Buy-Sell Agreement may address the following rights of minority and majority owners when either sells his or her shares.
(a) “Drag Along” Provision: Such a provision provides that if the majority owner sells to a third party, the majority owner can require minority owner(s) to sell their shares to the third party on the same terms and purchase price per share. This provision makes it easier for the majority owner to sell the company. Without a “drag along” provision, a prospective buyer who is only interested in purchasing 100% of the shares may walk away from the deal if one or more small shareholders refuse to accept the terms of the sale.
Do you want to include a “drag along” provision? Yes No
(b) “Tag Along” Provision: Such a provision provides that if the majority owner sells to a third party, the minority owner(s) may “tag along” and obtain the same terms and purchase price per share. This provision makes it more difficult for the majority owner to negotiate a “sweat heart” deal for the sale of his/her shares while leaving the other owners behind. In order for the majority owner to sell, the buyer must offer the same terms to all shareholders (large and small).
Do you want to include a “tag along” provision? Yes No
17. Owner Compensation: Compensation of the owners for services rendered (e.g., salary or wages) can greatly affect the remaining profits available for distribution to the remaining owners. Unless otherwise limited by agreement of the owners, and subject to the “business judgment rule,” the majority owner(s) of the company typically can set the reasonable compensation of the officers, directors, and employees (including themselves). To prevent the majority owner(s) from taking a substantial amount of profits out of the company in the form of unreasonable wage compensation, salary, or bonuses, the owners sometimes agree to limitations on such forms of compensation.
Do you want to limit owner compensation? Yes No
If so, indicate the methods you would like to use for limiting owner compensation:
Fixed per written agreement Yes No
Fixed plus maximum percentage increases per year Yes No
Not to exceed certain dollar amount Yes No
Must be approved by following vote of shareholders: 100% Majority Vote _______%
18. Profit Distributions: Generally, the law imposes statutory restrictions on the distribution of profits in a corporation so that owners do not receive profit distributions while creditors go unpaid. Assuming that the corporation is paying creditors and realizing profits, however, the general rule is that the board of directors can issue “profit distributions” to the owner(s) as deemed appropriate. Sometimes, the owners may disagree about whether to make profit distributions; how often they should be made; and in what amount. Typically, the minority owner(s) cannot control when profit distributions are made, because the majority owner controls the board of directors. If the board of directors chooses not to issue profit distributions, the minority owner(s) may suffer. Sometimes, withholding profit distributions is a strategy used by the majority owner to “squeeze out” the minority owner(s) and force them to sell back their stock. This is especially true in S-Corporations. Under the tax laws, the net taxable income realized by the S-Corporation is imputed to the shareholders based on the percentage of stock that they own. In turn, the shareholders must pay income tax on this imputed income (which is reflected on IRS Schedule K-1). For a limited liability company (LLC) that has elected to be taxed as a partnership, this is also generally the case. The shareholder must pay income tax on this imputed K-1 income regardless of whether the net income (profits) have been distributed to the shareholders. As a result, the minority shareholder(s) may end up paying significant tax on income they have never received. For this reason, many Buy-Sell Agreements spell out a procedure for declaring profit distributions.
How often must the corporation make profit distributions (assuming profits are available)?
Monthly?
Quarterly?
Yearly?
At the discretion of the board of directors?
Is the company required to pay profit distributions at the end of the year in a minimum amount sufficient to cover each shareholder’s estimated income tax liability for
corporate/partnership earnings?
Yes No
19. Instructions: If you want to schedule an Initial Minnesota Buy-Sell Legal Consultation with Trepanier MacGillis Battina P.A. law firm located in Minneapolis, Minnesota, complete this checklist and then contact the firm. You should NOT send the completed checklist to Trepanier MacGillis Battina P.A. until you have been briefly interviewed and you have disclosed the name of the corporation and all of its owners. A “conflicts check” must be performed before any consultation can be scheduled. If you send information to Trepanier MacGillis Battina P.A. before the “conflicts check” has been cleared and the law firm has scheduled the consultation, there will be no guarantee of confidentiality for the information that you send and it will not be protected by the attorney-client privilege.