OWM Newsletter
September, 2010
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Attorney Spotlight Gary L. Stein, Esq., is a graduate of the University of California at Berkeley and the Northeastern University School of Law in Boston, MA.  He is married, the father of three children and a new grandfather. Mr. Stein is Of Counsel to O’Donnell, Weiss & Mattei, P.C. His areas of practice include all facets of Business Law and Business Planning, Commercial Law and Real Estate Law.  He is a member of the Montgomery County and Pennsylvania Bar Associations. Phone: 610.323-2800 Fax: 610-718-1365 Email: gstein@owmlaw.com   The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

The Importance of Pre-Negotiated Agreements in Closely-Held Business Entities

Before a client forms or invests in a business entity with any other parties, it is critical that an agreement be negotiated which governs the conduct of the parties in connection with that business.  For a corporation, the agreement is known as a Shareholder Agreement.  For a limited liability company, the relevant provisions will be found in the Operating Agreement.  For a general or limited partnership, the same provisions will be found in the Partnership Agreement.  Whatever the business entity, the concerns and potential problems are the same.  In addition, those concerns and potential problems are equally applicable to a business venture with friends or relatives as with acquaintances.

The most important issues are those pertaining to restrictions upon the transferability of shares of stock, interests in a limited liability company or interests in a partnership.  Most parties in a closely-held business want to limit who may participate in that business with them.  In order to ensure that the other stakeholders have a voice in that process, an agreement should provide that either the business entity or the remaining interest-holders may acquire the departing party’s interest upon the occurrence of certain triggering events.  Those events are usually death, disability, termination of employment or a desire of a party to sell his or her interests in the business.  When one of those events occurs, an agreement with buy-sell provisions will provide for either a mandatory purchase or a discretionary purchase of the departing party’s interest in the business entity.  For a discretionary purchase, the agreement will grant rights of first refusal to the business entity and/or remaining interest holders.

A major advantage of pre-negotiated buy-sell provisions is that they are agreed to when the entity is formed and when relations between the parties are good.  When a triggering event occurs, emotion will usually be involved regardless of the nature of the triggering event.  Under such an agreement, the remaining shareholders of a corporation or interest-holders in an LLC or partnership will know exactly what their rights are upon the occurrence of the triggering event.  A good agreement will specify methods of valuing the departing member's interest in the business and paying the required amount for that interest.

While well-drafted buy-sell provisions will protect the remaining shareholders or interest-holders of a business, they may also provide liquidity and attempt to assure an exit strategy for the departing shareholder or interest-holder.  Whether the triggering event is death, disability, termination of employment or merely a desire to leave the business, the advantage of good buy-sell terms is that the departing party’s interest in the business can be sold upon pre-negotiated terms.  Those terms can be used to generate cash for the departing party or his/her estate.  In the event of death, life insurance is often used to guarantee that the funds for the stock purchase are available to the entity or the remaining interest-holders.

Minority shareholders or interest-holders may look to these agreements to prevent the majority from "freezing them out" of a variety of situations.  One common example is the incorporation of “tag along” provisions which permit a minority shareholder or interest-holder to participate in the sale of a majority holder’s interest in the business.

Other common uses of these agreements are for the following purposes:

• To determine management of the business and other governance issues
• To plan for succession of management responsibilities or ownership
• To provide a system for resolving disputes within management

As an investor in a business entity, you cannot afford to be unprotected by an agreement with the other investors on these issues. 

Beginning of Year Review Time

The beginning of the year is not only the time to start thinking about taxes, it also the time to make sure your estate plan is in order. It is a great time to review your Wills, Powers of Attorney, Life Insurance and Retirement accounts, to name a few things.

If revisions are needed you should contact your professional advisors, including your attorney, accountant and financial planner.

UPCOMING EVENTS

Read Legal Ease every other Sunday in the Pottstown Mercury.

See Legal Talk, brought to you by OWM, on PCTV, Tuesdays at 8:30 on Channel 28, and Thursdays at 9:30 p.m. on Channel 98, and also on our website at  http://www.owmlaw.com/legal_talk/legal_talk.php.

David A. Megay, Esq., and James C. Kovaleski, Esq., speaking at SCORE business planning seminars on 11/8/10, 1/10/11, 4/25/11, 9/12/11, and 11/7/11 (contact SCORE at 610-327-2673).

David A. Megay, Esq., speaking at Owen J. Roberts Adult Education 9/20/10 real estate transaction seminar and 10/4/10 business planning seminar (contact Owen J. Roberts Adult Education at 610-469-5830).

O'Donnell,Weiss & Mattei, P.C.

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