31 Dec Small business buy outs

Small Business Buy Outs

Most small businesses owned by more than one person will eventually face the situation where one of the owners will want to leave the business. In these situations, which are sometimes referred to as small business buy outs, the departing owner will want to sell his or her shares. Unless there is a buy-sell agreement already in place, the question becomes how to effectively negotiate that sale and complete the ownership transition through a small business buy out. Skillfully navigating these considerations are also an important part of buying and selling a business.

The departing owner has three options in selling his or her shares: 1) Sell the shares back to the company; 2) Sell the shares to one or more of the other owners; or 3) Sell the shares to an outside third party. The third option is the least common because the shares will be difficult to value, particularly for outside third parties; there will be little interest from outside third parties unless the selling shareholder controls a majority interest in the company; and outside third parties rarely will want to be involved in running a small business with others with whom they don’t have a pre-existing relationship. Moreover, small businesses often have multiple restrictions that prevent shareholders from even being permitted to sell their shares to outside third parties.

Since the first two options are the most common, this article will focus on those options and will discuss some of the issues that need to considered in such a sale. (As an aside, for the sake of simplicity, this article discusses shares in a corporation. If you own an LLC, your interests, or “units,” are essentially your shares.)

The key document memorializing the transition will be a stock purchase agreement. Within that document, the critical issues to address will be the purchase price, payment terms, collateral (if any) and the division of liabilities.

Critical Issues in a Small Business Buy Out

From a seller’s perspective, one of the most critical issues is simply getting paid. He or she will want to sell the shares to whichever party has more money–either the company itself or any of the remaining co-owners. If the business is still relatively new, and has not established capital reserves, then the best purchaser may be one of the co-owners.

Regardless of which party is the purchaser, a seller would be well advised to obtain guarantees, unless full payment is made up front. If the payment is not made up front–this is usually the case–then the buyer will offer a down payment as well as a promissory note establishing the remaining payment terms. Like the purchase price, the details of that note will be the result of the negotiations between the purchaser and seller.

The seller will most likely want to have the promissory note secured with some sort of collateral. Often times the collateral will consist of property owned by the buyer, a pledge of stock or the company assets.

In order to determine the price, the parties can either freely negotiate a fair price or work with outside appraisers to establish that price. The company’s accountant may also be a good resource in assisting the parties in determining a fair price. In this vein, both the seller and buyer should keep in mind that there will be important tax consequences resulting from the sale, and they should consult with an accountant about those issues.

Other Considerations

In a small business, it is likely for shareholders to guarantee the company’s debts. (This is common, for instance, in the case of a commercial lease.) As part of his or her sale of shares, a selling shareholder will want to ensure that he or she will no longer be responsible for those types of guarantees after the sale. To do so, the seller should negotiate a provision to indemnify him or her in the case where a third party does sue on such a guarantee.

Further, parties negotiating a stock purchase agreement also should keep in mind the difference between corporate stock and assets. A properly structured company will own all of the assets that were used in the business, and a selling shareholder should be cognizant of the fact that, by selling his or her shares, he or she will not have any rights to take or use any of the company’s assets (such as the company cars, equipment, licenses, memorabilia etc.) after the sale. If the selling shareholder wishes to either take or use any such assets, he or she should consider negotiating and drafting separate agreements with the company as to those assets.

Author: Andrew Harris

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To continue reading more about the laws that might affect your business, please see the Articles page, or to simply see a list of helpful legal resources for Oregon startups and businesses, please see the Legal Resources page.

If you are interested in buying or selling shares in an Oregon business or want to learn more about buying and selling a business, please contact us.