Cashing out from employee ownership

July 1, 2002 By    

The success of most every propane retailer can be traced to the hard-working, dedicated men and women who daily service customers on the front lines of those businesses. As a way to reward their performance and keep them from going to work elsewhere, some companies give their valued employees an option to purchase a small ownership interest in the business – shares of stock, units or ownership interests in a limited liability company or partnership.

In order to protect the employee, the owner and the business, there are several vital elements that should be included in the legal documents that govern these arrangements.

These items are not intended to address issues between equal owners of a business, nor issues pertaining to an equity investor purchasing a significant ownership interest in a business. We’ll talk about those items at a later date.

If a business gets sold, the employee and majority owner of the business expect to receive a portion of the sale proceeds based on their proportionate ownership interest. The agreement governing these arrangements is typically called a stock/equity purchase or repurchase agreement. It is the document that addresses the difficult issues of how, when and at what prices the business may repurchase the employee’s ownership interest.

Owners should insist on these types of agreements in order to prevent the employee’s ownership interest in a closely held business from passing to outsiders. Employees should want them to provide for the liquidation to cash of their investment.

The first consideration is commonly called a “go along/come along.” This catchy phrase simply means that if the majority owner sells out, the employee gets to sell on the same terms and at the same price as the majority owner. Hence, the “go along.” It prevents the employee from being left as a minority owner with a new and unknown majority owner.

The provision also means that the majority owner can compel the employee to sell on the same terms and at the same price – hence, the “come along.” It permits the majority owner to deliver 100 percent of the ownership interest in the business to a buyer.

A related scenario arises when the employee receives or solicits a true, market-price offer for the purchase of only his or her ownership interest (not the majority owner’s interest). Under the laws of most states, a prohibition on the transfer or sale of the employee’s shares to an “outsider” is not enforceable.

The agreement often provides that, if the employee receives such an offer and wants to sell, the business or the majority owner has the option to purchase the employee’s interest. The price of the purchase is negotiable. Usually, it is tied to the price offered by the third party, or the “contract price” negotiated for purchase upon cessation of employment.

All of the above is relatively simple and not particularly contentious. But what happens if the employee leaves the company and there is no third-party buyer to establish the sales price?

The premise is that the majority owner does not wish to have a portion of the business owned by a non-involved party, and that the former employee does not wish to own a minority interest in a business with which he or she has no involvement. There is no legal requirement – absent a contract – for the owner to buy or for the employee to sell the interest when employment ends.

There are three primary issues to consider in connection with the repurchase of an employee’s interest once he or she leaves the company:

  • What is the formula or contract price upon repurchase (appraisal, cash-flow multiple, book value, cents per gallon)?
  • Does the business or majority owner have the obligation or the option to repurchase the employee’s interest based on certain events?
  • Over what period of time will the repurchase be paid to the employee?

Answering these questions may well depend on the circumstances for ending the employment: employee’s death; involuntary “sale” of the employee’s ownership interest (bankruptcy, divorce, etc.); voluntary resignation by the employee; termination by the employer without cause; termination by the employer for cause; employee’s retirement; and employee’s disability.

Unfortunately, space does not permit a full discussion on each of the above. Also, we have not addressed the applicable tax and minority shareholder concerns for all parties in transactions of this nature.

As always, I encourage you to consult your legal advisor about all of the legal and business issues involved.

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