Small businesses with a limited number of shareholders – sometimes referred to as closely held businesses – face an obstacle that larger, publicly traded companies do not: liquidity. Liquidity is simply a term used to describe the degree an interest, or share, in a company can be readily bought or sold. For example, in the context of a small company, it is often that the only person(s) interested in selling (or purchasing) shares in the company are the members of the company themselves. In other words, in a company owned by two individuals, each with a 50% interest in the company, it is likely that the only market for those shares is the other 50% shareholder. Compare this relationship to a company listed on a stock exchange and you can see that small companies have a liquidity problem. That is, owners of these companies do not have the ability to easily buy or sell shares in their company without the co-operation of their partner(s).
In a working business relationship, where partners co-operate with one another, the partners may reach an agreement on the purchase price of the selling partner’s shares. For example, in a 50/50 partnership where one partner wishes to retire, the partners may employ the services of an accountant to evaluate the company and determine its fair value, or price. In turn, this price can be used to determine the purchase price of the selling partner’s shares. Once the price of the shares is agreed upon, the parties should employ an attorney to draft a Buyout Agreement, which will contain the price figures as well as other essential terms.
It is vitally important to reduce the agreement of the parties to writing and include the appropriate, material provisions. Even more important is to create a contract provision at the outset of the business relationship that covers share repurchasing, sale, or buyouts so that an issue does not arise once one partner, for example, announces his or her retirement. No matter the relationship between the parties, it is not recommended that an individual attempt to author a Buyout Agreement or related provision without the assistance of trained legal counsel.
With that said, partners may not always agree with each other on material terms including price and valuation, in effect, making a Buyout Agreement difficult or impossible to reach. In that case, if a buyout provision does not exist in the company’s corporate documents to contractually bind the partners, a partner might ask what his or her legal options are to protect themselves or the corporation. Fortunately, New Jersey state law offers protections for the above issues, and others, through its Shareholder Statute (N.J.S.A. 14A:12-7). In some situations, a company may already have a buyout provision in place through its corporate documents, such as its operating agreement or bylaws.