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Shareholder Agreements: Liability or Invaluable Contract?
Remember when your company was formed and you were advised to have a shareholder agreement or shareholder buy-sell agreement prepared? If you haven't reviewed the agreement periodically as part of your regular business planning, it could turn out to be a liability instead of the invaluable contract it was meant to be.
What is a shareholders’ agreement?
Simply put, it's an agreement between shareholders and/or the company regarding each person's rights and obligations. It can ensure the protection of shareholder rights and fair treatment for all parties, but it can also be a liability.
How can it be an invaluable contract?
- Prevents stock from transferring to undesirable parties
- Provides a market for the stock
- Protects minority shareholder rights
- Outlines procedures for valuing the stock for transactions
- Establishes the terms of stock transactions
How can it be a liability?
- Does not reflect current corporate structure or ownership
- Required purchase price is not reflective of fair market value
- Terms of stock purchase not at market rates
- Missing triggering events such as permanent disability, retirement, or termination of employment
Avoid these two scenarios
Let’s talk about what can happen when the stock price is not reflective of fair market value. This might occur when a fixed or formula price in an agreement is not routinely reviewed. I have seen an agreement that stipulates a multiple of earnings of 15 be used. Such a high number could result in a stock price significantly higher than fair market value. If a stock transaction is triggered, the liability could destroy the company or shareholders financially.
Another example is when a fixed price has not been updated in many years, which can result in an unintended liability for a shareholder’s estate. Normally, the estate of a decedent is taxed on the fair market value of the stock regardless of what the estate must sell it for under a shareholders’ agreement.
I have seen agreements where, if a transaction were triggered by the death of a shareholder, the estate must sell its stock to the company or other shareholders at a fixed price that is less than the estate tax due on the fair market value of the stock!
How we can help
Agreements can be fixed, but it needs to be done before a transaction or disagreement occurs. So pull that document out of the file cabinet and take a look at it with a trusted advisor and legal counsel. If you don't have an agreement in place, you have virtually no control over the valuation or disposition of the stock upon a life-changing event.
Take control of your company’s future by drafting a proper agreement that will be an asset — and not a liability.