Liability
Most lenders require personal guarantees to secure financing. A contribution agreement among guarantors ensures that responsibility is divided along the same lines as shareholder ownership. This prevents the bank from forcing the guarantor with the deepest pockets to cough up money in default cases. If only one shareholder guarantees the loan, he may ask for a guarantee fee from the company to compensate him for assuming all the risk. Paying a fee ensures guarantors that management is motivated to produce positive results. The fee is higher if the company can’t survive without the guarantor’s signature, and smaller if a company’s higher net worth diminishes the guarantor’s risk.
Role of Equity
How many classes of stock, or membership interests, should you have? Do voting rights differ for each? Which is best for you? It’s an oversimplification, but let’s say one class of stock provides for only equity and financial rights, while another class receives those rights plus voting privileges. The former may be fine for passive investors; the latter is the province of players who want a say on strategic decisions.
Value of Contributions
Make sure the executive-compensation program is in writing, whether for common stock awarded in exchange for sweat equity or for stock options granted to key employees. For stock options, calculate the tax implications and make sure they’re properly recorded on the company’s ledger.
Exit Strategy
This hot button gets everyone’s attention. How will principals cash in their chips? Under what circumstances can shareholders—angels, VCs, Grandma—force the company onto the block to recoup their investment? Beware of somebody inconspicuously slipping in this common yet onerous provision.
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Strategic Financial Planning
Long-range objectives may be undermined if the buy-sell agreement, exit strategy, and other aspects of ownership are not seamlessly coordinated with estate and succession planning. Once or twice a year, gather your team (attorney, accountant, estate planner, insurance planner, and others) to make sure all angles are covered. Don’t rely on just one expert’s opinion. Your attorney may have a brilliant legal mind, but unless he’s also tax savvy, he may overlook important IRS ramifications.
Shareholders’ Buy-Sell Agreement
This document addresses the closely held company’s valuation, how shareholders must first offer their stock to the company or insiders, and what happens upon the death of a shareholder. In fact, include a life insurance plan here so in the event of a principal shareholder’s death, a buyout doesn’t break the company bank. Each shareholder should have his or her own attorney eyeball these issues. Details of shareholders’ agreements can vary depending on the cause of the cash-out.
For instance, if a shareholder voluntarily gets off the bus before it reaches its destination, buyout price and payment terms may be more draconian than if a shareholder dies or is disabled. To protect majority shareholders, include a “drag along” provision that contractually requires all shareholders to participate in a sale at the same price per share (many buyers, especially big private equity firms, only want to buy 100 percent ownership).
Last word
To protect minority shareholders, include a “tag along” provision that guarantees that all shareholders can participate in a sale at the same price per share should the majority decide to sell.
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