Buy-out Considerations

When a founder departs a start-up company, he or she typically disposes of his or her equity stake by selling it to one of three entities: 1) back to the company; 2) to other equity holders of the company; or 3) to a third-party. There are many important considerations involved in a transaction to purchase a departing founder’s equity stake, such as: 1) Founders’/Shareholders’ Agreement: Typically, founders will have executed some sort of agreement among themselves that dictates many of the important terms for a buy-out. For example, a departing founder may be required to first offer his or her stake to the company or to the other stakeholders; or, if the departing founder has a bona-fide third-party purchaser for his or her stake, the company or the other equity holders may have a right of first refusals — that is, they have the right to purchase the stake along the same terms as the deal with the bona-fide third-party purchaser. 2) Price: Assuming that a third-party bona fide offer is not in play, a price for the equity stake will need to be set. Usually, an agreement among the founders will set a price (often required to be updated on a semi-annual or annual basis) or a means for determining a price, such as by some valuation formula or agreeing to retain valuation advisors. 3) Payment: An agreement among founders may also dictate terms of payment. Usually, the company or founder purchaser(s) put a down payment on the purchase price, with the balance secured by a promissory note. The purchase price can also be secured by some sort of collateral. 4) Taxes: Buyers and sellers should retain tax advisors, as there are likely to be tax consequences of the sale for both the seller and the buyers, as well as possibly the company itself if it is not the buyer. 5) Liabilities: Sellers will also want to negotiate the release of any liabilities they may have to the company as well as a result of their ownership of the company. This is particularly important if the departing founder has personally guaranteed liabilities of the company, such as debt or leases of property or equipment. 6) Assets: If the departing founder contributed specific assets to the company, the founding agreements may control the founder’s rights to those assets on departure. Otherwise, they may be solely the property of the company, so that if the departing founder wishes to retrieve those assets, it will need to be agreed to.

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