A stock redemption agreement is a legally binding contract between two companies — a corporation and a stockholder — that protects both parties in case of death, retirement, or other events that could lead to the dissolution of the business. The agreement essentially buys out the stockholder to ensure the business remains intact. Here is a closer look at why these agreements are beneficial to both parties and what legal protection they offer.
Stock Redemption Agreement: What Must Every Lawyer Know?
Updated October 31, 2023
8 min read
Introduction
What Is a Stock Redemption Agreement?
Stock redemption agreements are a type of buy-and-sell agreement between a corporation and a stockholder designed to protect investors and the business from ending up in an unfavorable position. It outlines how shares will be reassigned and the specific redemption rights of each party in the event of an owner leaving the business. For example, in the case of the death of a stockholder, the agreement will determine that the shares are sold back to the company as treasury stock in exchange for cash or property.
Stock redemption agreements can also be used as a vehicle for the planned transfer of a business interest. This could include the formation of new business partnerships, the acquisition of a part of the business by a third party, or the transition to a limited liability company (LLC).
Benefits of a Stock Redemption Agreement
Once signed, a stock redemption agreement is a legally binding document. They ensure stability in unlikely or unfortunate events. When business owners exit the company or become incapacitated — due to death, retirement, disability, or personal bankruptcy — the company will be liable to buy out the deceased’s shares in the business, thus favoring the stockholder. There are many reasons and benefits for filing a stock redemption agreement. These include:
Allowing business continuity if a partner dies or otherwise exits the business.
Ensuring a guaranteed buyer for the business shares.
Maintaining ownership of the business within the people selected by the current owners.
Providing financial support to the family of the deceased.
Avoiding any potential conflict of interest.
Providing liquidity for settlement expenses and taxes.
How To File a Stock Redemption Agreement?
Most transactions start with one party submitting a letter of intent to the other detailing their request. Both the buyer and seller can initiate drafting the contract, but it is usually the buyer, as they benefit most from the protection covered by the contract.
If both parties are happy to pursue the deal, then the legal document is drafted. You can easily find a stock redemption agreement sample or template online at reliable legaltech ecosystem Lawrina to help with the formatting and language. However, as a legally binding contract, stock redemption agreements are long and complex with several different annexes and must be written using specific legal terminology. Because of this, they are best left to an attorney.
For the agreement to stand, it then has to be signed by both stockholders with a witness present. A signed copy of the document will then be given to each party to keep on record. When needed, either party can present the contract and release the funds or stocks to the other party as outlined.
Check out a Stock Purchase Agreement (SPA), a legal document businesses use to transfer shares from a business to a new buyer. Without an SPA, no sale is considered legally binding, which could put the business at financial risk and lead to potential litigation.
What Should Be Included in a Stock Redemption Agreement?
Each stock redemption agreement is unique for each situation, containing information specific to both the corporation’s and the stockholder’s wants and needs. However, the basic structure of the document is generic and includes the following sections:
Payment: Detailing the amount of payment the corporation will be required to compensate the leaving shareholder and the method used for delivery.
Voting rights: Where applicable, this section details if there are any voting rights on the stock in question and how this will become nullified once the shares have been transferred.
Shareholder warranties: The stockholder will assure that they are the sole owner of the stocks in the discussion by providing appropriate transfer and release documentation. This prevents any potential conflict.
Corporation warranties: Similarly, the corporation will provide a warranty that the redemption agreement will not conflict with any other laws or contracts in place that could restrict the redemption of stock.
Expenses: For any costs involved, the expenses subsection details which party will be liable to pay what.
Severability: This section explains that if any of the agreement is proven to be invalid, all other sections of the document are upheld and remain legally binding.
Binding agreement: The contract must contain a binding agreement to be legally intact. It states that the document stands until termination.
Acceptance: At the end of the document, there will be an acceptance which requires a signature from both parties to agree to the terms and conditions.
For any lawyer consistently dealing with these agreements, it is advisable to create a stock redemption agreement form that contains all of the above sections. This can then be edited with the unique details and requirements for each client, personalizing it for each case.
Final Thoughts
Stock-redemption agreements are a worthwhile consideration for any parties involved in acquiring shares in a business to protect the shareholder and to keep the company intact. They detail the process in which the stockholder can be bought out in the event of death, retirement, disability, or other forms of incapacitation. Lawyers will need to draft the legally binding document, following a set structure and using legal terminology to ensure it holds up and that both parties receive the agreed stock redemption.
Article by Yevheniia Savchenko
Frequently Asked Questions
What are the key elements to include in a stock redemption agreement?
Key elements of a stock redemption agreement include the valuation of the shares, the triggering events for redemption, and how the purchase will be financed. The way the company values its shares is a critical part of the agreement because it determines the price to be paid when the shares are redeemed.
Triggering events are specific circumstances under which the corporation must buy back its shares. The agreement should clearly outline how the buyback will be financed; this could be through insurance, corporate earnings, or a combination of these. The agreement should also dictate any actions or restrictions placed upon the shareholder upon exiting the corporation.
How does a stock redemption agreement benefit both the corporation and the stockholder?
For a corporation, a stock redemption agreement ensures stability by giving it control over who owns its shares. This can prevent a situation where shares end up with someone who may not have the company's best interests at heart, such as a former employee's spouse or a competitor. It also provides a clear succession plan, which is especially crucial for smaller or family-owned businesses.
For stockholders, a redemption agreement offers a clear exit strategy. It gives them a guaranteed buyer for their shares and spells out the terms of the buyout, including the share price. This can be particularly beneficial in privately held companies where shares can't be easily sold in the open market. Thus, the agreement provides protection and certainty to both parties involved.
Are there any potential downsides to a stock redemption agreement?
While a stock redemption agreement offers several benefits, potential downsides do exist and must be carefully considered. The redemption cost might strain the corporation's finances, especially if it happens unexpectedly or if multiple redemptions occur simultaneously. Therefore, provisions detailing how the redemption will be financed are crucial.
From the stockholder's perspective, the valuation of shares in the agreement might not reflect the future value of these shares. They could potentially receive less than if they sold their shares in an open market or to a private buyer. Therefore, a lawyer must carefully draft the agreement, keeping the interests of their client in mind while balancing both parties' needs.