How can a redemption agreement help shareholders avoid disputes over valuation?

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If you are a shareholder in a closely held corporation, you may face some challenges when you want to sell your shares or exit the business. How do you determine the fair value of your shares? How do you find a willing buyer? How do you avoid conflicts with the remaining shareholders? One possible solution is to use a redemption agreement, also known as a stock redemption agreement or a corporate repurchase agreement. This is a type of buy-sell agreement that allows the corporation to buy back your shares at a predetermined price and terms. In this article, we will explain how a redemption agreement can help shareholders avoid disputes over valuation and some of the advantages and disadvantages of this option.

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Svyatoslav Tsypin

?? Эксперт по слияниям и поглощениям (M&A) с 25 летним опытом | ?? Помогаю находить, покупать и продавать предприятия |…
Reggie Young

Exit Advisor & Agency Founder | Forbes Council, M&A, Growth and Operations

1 What is a redemption agreement?

A redemption agreement is a legal contract between a corporation and its shareholders that specifies how the corporation can buy back the shares of a departing shareholder. The agreement usually sets the price, timing, and method of payment for the repurchase. The price can be based on a formula, an appraisal, or a fixed amount. The timing can be triggered by certain events, such as death, disability, retirement, or divorce. The method of payment can be cash, installments, or notes.

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Svyatoslav Tsypin

?? Эксперт по слияниям и поглощениям (M&A) с 25 летним опытом | ?? Помогаю находить, покупать и продавать предприятия | ?? Знаю, как найти и приобрести лучшие компании | ?? Создаю идеальные сделки с ценными активами
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A redemption agreement allows shareholders to determine in advance the terms of the buyout of shares in the event of the withdrawal of one of the participants. It establishes a formula or mechanism for assessing the value of shares, which eliminates subjective approaches and market fluctuations at the time of disagreement. For example, you can use an EBITDA multiplier or a net profit indicator agreed on the basis of past periods. By concluding a redemption, the parties minimize the risk of litigation and reduce the time spent on negotiations, since the key parameters of the transaction have already been fixed. This is especially important in a takeover, where an accurate assessment of the value of shares is critical for all parties.

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Reggie Young

Exit Advisor & Agency Founder | Forbes Council, M&A, Growth and Operations
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A redemption agreement is crucial for ensuring smooth shareholder exits. Beyond basic valuation, consider incorporating a dynamic pricing model that adjusts based on market conditions or business milestones. Implementing an arbitration clause can also preempt lengthy disputes. Regularly update the agreement to reflect current financial health and industry trends, maintaining fairness and clarity.

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2 How does a redemption agreement avoid valuation disputes?

A redemption agreement can help shareholders avoid valuation disputes by providing a clear and agreed-upon mechanism for determining the value of their shares. This can reduce the risk of litigation, arbitration, or negotiation among shareholders who may have different opinions or interests regarding the value of the business. By having a redemption agreement in place, shareholders can avoid the uncertainty and costs of hiring experts, conducting valuations, or engaging in disputes that may damage the relationship and reputation of the business.

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Reggie Young

Exit Advisor & Agency Founder | Forbes Council, M&A, Growth and Operations
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To avoid valuation disputes, leverage an independent third-party valuation service specified in the redemption agreement, updated annually. This prevents bias and ensures current market reflection. Also, include a dispute resolution clause that mandates mediation before any legal action. Regular shareholder meetings to discuss and revise the valuation method can foster transparency and mutual understanding.

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3 What are the advantages of a redemption agreement?

A redemption agreement can offer some advantages for both the corporation and the departing shareholder. For the corporation, a redemption agreement can allow it to retain control over its ownership structure and avoid having unwanted or unqualified shareholders. It can also prevent the dilution of the remaining shareholders' interests and maintain the continuity and stability of the business. For the departing shareholder, a redemption agreement can provide a guaranteed and convenient way to sell their shares and receive liquidity. It can also offer some tax benefits, such as avoiding double taxation on the proceeds and deducting the interest payments on notes.

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4 What are the disadvantages of a redemption agreement?

A redemption agreement can also have some drawbacks for both parties. For the corporation, a redemption agreement can create a financial burden and reduce its working capital and cash flow. It may also affect its creditworthiness and ability to borrow funds or raise capital. For the departing shareholder, a redemption agreement can limit their options and flexibility to sell their shares to other parties or at a higher price. It may also expose them to the risk of default by the corporation or changes in the tax laws.

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5 How to create a redemption agreement?

Creating a redemption agreement is essential for protecting the interests of both the corporation and the shareholders. It must be consistent with the articles of incorporation, bylaws, and other governing documents of the business. A redemption agreement should include key elements such as the triggering events that allow or require the corporation to buy back shares, the valuation method and price for the shares, payment terms and conditions, rights and obligations of both parties, dispute resolution process and remedies, and tax implications and consequences. Understanding how a redemption agreement works and what it entails can help shareholders plan an exit strategy and avoid disputes over valuation.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can a redemption agreement help shareholders avoid disputes over valuation?

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1 What is a redemption agreement?

2 How does a redemption agreement avoid valuation disputes?

3 What are the advantages of a redemption agreement?

4 What are the disadvantages of a redemption agreement?

5 How to create a redemption agreement?

6 Here’s what else to consider

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