In a case study of three close friends who started a business, Don Bays (Henry & Horne) demonstrates the need for a well-written shareholder agreement—including the following:
- Valuation date: What is the date of the valuation of the departing (or deceased’s stock)? Is it the date of termination? The date of death (as may be required for estate tax purposes)? Or the date of the end of the latest fiscal year?
- Value to be used: Will it be book value (possibly useful for companies with a high concentration of liquid receivables and inventory assets as compared to fixed assets); or, adjusted net asset value (the fair market value of tangible assets less liabilities, plus the value of intangibles such as goodwill, patents, and copyrights); or, a fair market value based on the economic earnings of the company, or the ratio of selling price to revenues of similar companies (a direct market data method of business valuation)?
- Discounts: Will minority and marketability discounts be applied to the shares or will they be redeemed at one-third of the 100% of the value of the company, however value is determined?
- Annual valuations: Will the stock be valued on an annual basis so that the changing economics of the company are considered on a somewhat timely basis?
- Appraisers: Will a competent business appraiser be engaged to value the stock? (For estate tax purposes the Internal Revenue Services requires an independent opinion of value rendered by a qualified business appraiser)? Or will the value of the stock be negotiated by the remaining owners of the company?
- Life insurance: Will the purchase of the stock be funded by life insurance?
- Unwanted owners: Does the shareholder agreement stipulate that the departing or deceased shareholder cannot sell its shares to anyone other than the remaining stockholder?