DRAFTING BUY/SELL AGREEMENTS IN BUSINESS, PART 1 & PART

Transcription

1 DRAFTING BUY/SELL AGREEMENTS IN BUSINESS, PART 1 & PART 2 First Run Broadcast: December 4 & 5, 2012 Live Replay: March 7 & 8, :00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes each day) Buy/sell agreements are the principal means by which owners of a closely held business regularly value the company and provide a market for selling or exchanging interests in the company. Without buy/sell agreements there is little opportunity for retiring partners, or the estates of those who are deceased or bankrupt, to sell their interests in the company. There are a myriad of buy/sell alternatives involving the sale of interests among the owners, the owners and the company itself, or some blend of the two. The valuation methodology used for the buyout and funding sources are also essential for a successful buy/sell arrangement. This program will provide you with a draftsman s guide to the major components of a buy/sell agreement, discuss valuation and funding mechanisms, dispute resolution, and major tax issues. March 7, 2013 Part 1: Types and differences among buy/sell agreements cross-purchase, entity redemption, and hybrid approaches Framework of major provisions of buy/sell agreements Valuation methodologies and timing independent appraisals, formula clauses and more Rights of first offer v. rights of first refusal Different issues involving retirement v. death v. bankruptcy of departing owner March 8, 2013 Part 2: Funding buy/sell agreements key-man insurance, loans, other funding sources Special buy/sell issues involving S Corps and unincorporated entities Drag-along and tag-along rights in buy/sell agreements Major tax issues in buy/sell agreements Common traps in planning and drafting agreements in closely held businesses and dispute resolution Speakers: Patrick J. Linden is special counsel in the Denver office of Faegre Baker Daniels, LLP, where his practice focuses on corporate, securities and transactional law for clients ranging from startups and emerging growth clients to Fortune 500 companies. He has extensive experience with public and private mergers and acquisitions and routinely represents clients in their equity and debt financing activities. He also represents private equity and venture capital funds in their investment and M&A transactions. Mr. Linden received his B.S./B.A., cum laude, from the University of Denver, M.S. in finance from the University of Denver, and his J.D. from the University of Denver College of Law. Trygve Kjellsen is a partner in the Denver office of Faegre Baker Daniels, LLP, where his practice involves the full range of corporate and securities work, with an emphasis on mergers

2 and acquisitions, strategic alliances and finance. He also has extensive experience advising foreign clients on their private equity investments in US companies. Before entering law practice, he worked in the financial services industry. Mr. Kjellsen earned his B.S., cum laude, from Truman State University and his J.D. from Rutgers School of Law.

3 PROFESSIONAL EDUCATION BROADCAST NETWORK Speaker Contact Information Drafting Buy/Sell Agreements in Business, Part 1 & Part 2 Patrick J. Linden Faegre Baker Daniels LLP Denver (o) (303) plinden@faegre.com Trygve Kjellsen Faegre Baker Daniels LLP - Denver (o) (303) trygve.kjellsen@faegrebd.com

4 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: Middle Initial: Last Name: Firm/Organization: Address: City: State: ZIP Code: Phone #: Fax #: Address: I will be attending: Drafting Buy/Sell Agreements in Business, Part 1 Teleseminar March 7, 2013 Early Registration Discount By 02/28/13 Registrations Received After 02/28/13 VBA Members: $70.00 Non VBA Members/Atty: $80.00 VBA Members: $80.00 Non-VBA Members/Atty: $90.00 NO REFUNDS AFTER February 28, 2013 PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association): $ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # Exp. Date Cardholder:

5 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: March 7, 2013 Seminar Title: Drafting Buy/Sell Agreements in Business, Part 1 Location: Credits: Teleseminar 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

6 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name: Middle Initial: Last Name: Firm/Organization: Address: City: State: ZIP Code: Phone #: Fax #: Address: I will be attending: Drafting Buy/Sell Agreements in Business, Part 2 Teleseminar March 8, 2013 Early Registration Discount By 03/01/13 Registrations Received After 03/01/13 VBA Members: $70.00 Non VBA Members/Atty: $80.00 VBA Members: $80.00 Non-VBA Members/Atty: $90.00 NO REFUNDS AFTER March 1, 2013 PLEASE NOTE: Due to New Hampshire Bar regulations, teleseminars cannot be used for New Hampshire CLE credit PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association): $ Credit Card (American Express, Discover, MasterCard or VISA) Credit Card # Exp. Date Cardholder:

7 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: March 8, 2013 Seminar Title: Drafting Buy/Sell Agreements in Business, Part 2 Location: Credits: Teleseminar 1.0 General MCLE Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

8 Buy/Sell Agreements, Part 1 Trygve E. Kjellsen Faegre Baker Daniels LLP - Denver (o) (303) trygve.kjellsen@faegrebd.com

9 Types and Differences Among Buy/Sell Agreements Importance and Purpose of Buy-Out Agreements Generally Succession Planning Tool Provide Certainty and Avoid Disputes Maintain Family Ownership Avoid Transfers to Non-Family Members Children of Patriarch and QTIP Trusts Grandchildren of Patriarch Unrelated Owners of Entity Surviving Owners of the Business 2

10 (Cont d) Types and Differences Among Buy/Sell Agreements Redemption Agreement Entity acquires the interest of departing stakeholder No step-up in tax basis to remaining stakeholders Potentially simple insurance arrangements Insurance proceeds NOT subject to the creditors of the other stakeholders Insurance proceeds ARE subject to the claims of creditors of the entity 3

11 (Cont d) Types and Differences Among Buy/Sell Agreements Cross Purchase Agreement Remaining stakeholders acquire the interest of departing stakeholder Step-up in tax basis and no dividend treatment Potentially complex Insurance proceeds ARE subject to the claims of creditors of other stakeholders Insurance proceeds NOT subject to the claims of creditors of the entity 4

12 (Cont d) Funding Buy/Sell Agreements Through Life Insurance Hybrid Agreement Option to both entity and the remaining stakeholders to acquire the interest of departing stakeholder Great flexibility 5

13 Considerations for Deciding Among the Three Types of Buy-Out Agreements Number of Stakeholders in the Entity Age of Owners Credit Considerations Tax Considerations Excessive Life Insurance Entity Owned by Several Families or Family Groups Solvency Considerations 6

14 Framework of Major Provisions Type of Entity Triggering Events Death Disability Termination of Employment Retirement Bankruptcy Divorce 7

15 (Cont d) Framework of Major Provisions Types of Buy-Sell Provisions Mandatory Purchase on Death Shotgun Buy-Sell Texas Shootout Right of First Offer Right of First Refusal Tag-Along Rights Drag-Along Rights 8

16 (Cont d) Framework of Major Provisions Determination of Purchase Price Determination of Fair Market Value Agreed Value Formula Approach Appraisal Approach Shotgun Price Valuation Discounts 9

17 (Cont d) Framework of Major Provisions Financing of Purchase Financing through Insurance Policy Entity s Ability to pay for the Ownership Interest Payment Over Time Security Devices 10

18 Triggering Events Occurrence of certain events trigger the operation of the agreement Stakeholder whose event triggered the operation of the agreement is required to sell his ownership interest in accordance with the terms of the agreement Common Trigger Events Death and Permanent Disability Mandatory Purchase v. Put and Call Options If transfers to descendants are permitted, and owner wants business to stay in his family, death may not be a trigger for the buy-out of his interest If transfers not permitted, death or permanent disability should trigger the buy-out provisions Put right to provide liquidity to estate or surviving spouse Defining Permanent Disability v. Temporary Incapacity 11

19 (Cont d) Triggering Events Termination of Employment or Other Defaults Employment requirement Engaging in competition Defining Cause Valuation Penalty; Purchase Price Discount Retirement Employment requirement Defining Retirement Minimum age Minimum number of years of service 12

20 (Cont d) Triggering Events Divorce Marital breakdown is a common triggering event Ex-spouse as fellow owner Application of Code Section 1041 Bankruptcy Bankruptcy and insolvency is a common triggering event 13

21 Buy-Sell Provisions Mandatory Purchase or Put and Call Options The company has the option to call (i.e., purchase) the shares The estate has the option to put (i.e., sell) the shares Shotgun Buy-Sell/Texas Shoot-Out Mechanics Controversial option 14

22 (Cont d) Buy-Sell Provisions Right of First Refusal and Right of First Offer Mechanics Pro-rata purchase right based on ownership percentages Relevance of ROFR Right of First Offer (ROFO) Mechanics Permitted Consideration Permitted Transfers Exempt From ROFR/ROFO Provisions 15

23 Valuation Methodologies Determination of purchase price of ownership interest is one of the most critical parts of the buy-out agreement Determination of Fair Market Value and Treasury Regulations Nature and history of the business from its inception Economic outlook The book value of the stock and the company s financial position Earning capacity of the company Dividend paying capacity of the company Existence of goodwill and other intangible assets Sales of stock and the block of stock to be valued Market price of similar stocks 16

24 (Cont d) Valuation Methodologies Periodic Agreement of Owners Cumbersome Requires discipline among owners Price may be stale Formula Approach Typically include consideration of book value and earnings Determination of capitalization rate Specify number of years over which the earnings will be averaged Earnings figure may not be accurate in a closely held C corporation May not yield an accurate result 17

25 (Cont d) Valuation Methodologies Appraisal Formula Approach Agreement should specify the time period during which the appraisal must be conducted Methods for picking appraiser(s) Agreement should specify whether the business is to be appraised as a going concern or strictly on the basis its hard assets and liabilities Determination of Price by Arbitration Shotgun Buy-Sell Valuation Discounts 18

26 BIOGRAPHY Trygve E. Kjellsen Trygve Kjellsen is a partner in the Denver office of Faegre Baker Daniels. His practice involves the full range of corporate and securities work, with an emphasis on mergers and acquisitions, complex strategic alliances and joint ventures, both domestically and internationally. Trygve s transactional expertise spans the range of M&A and joint venture activities, including representation of private and public companies in all aspects of M&A transactions, minority and strategic investments and equity and debt financings, and he also advises foreign clients in connection with their private equity investments in, or acquisitions of, companies in the United States. Trygve is a frequent lecturer at continuing legal education programs and is the co-editor of the business law section of The Colorado Lawyer. 19

27 Buy/Sell Agreements, Part 2 Patrick J. Linden Faegre Baker Daniels LLP Denver (o) (303) plinden@faegre.com

28 Introduction/Topics Funding Buy/Sell Agreements Key-Man Insurance, Loans and Other Funding Sources Special Buy/Sell Issues Involving S-Corps and Other Entities Tag-Along and Drag-Along Rights in Buy/Sell Agreements Tax Considerations in Buy/Sell Agreements Avoiding Traps Dispute Resolution Provisions 2

29 Funding Buy/Sell Agreements Key Man Insurance, Loans and Other Funding Sources 3

30 Funding Buy/Sell Agreements The probability of the death of at least one of two business owners at an age prior to 65 is surprisingly high. Expressed as the number of chances out of 100 that at least one of two business owners in relatively good health (able to qualify for standard insurance rates) will die before age 65, are as follows: Ages Chances out of / / / / / / Most buy-sells are funded with life insurance as it is the only means of guaranteeing that death, the event which creates the need for cash, also creates the cash to satisfy that need. 4

31 Funding Buy/Sell Agreements Through Life Insurance Who Owns the Life Insurance Policy? While not always the case, the general arrangement is for the partner(s), partnership, stockholder(s) or corporation (whoever is the purchaser specified in the agreement) to pay the premiums. The party(ies) paying the premiums is also generally the owner(s) of the policy and receives the proceeds of the policy at the death of the insured. [There can be many variations to this scenario]. The life insurance proceeds are used for the purpose of buying out the ownership interest of the deceased. 5

32 (Cont d) Funding Buy/Sell Agreements Through Life Insurance Benefits Low Cost Alternative: Total cost of annual premiums on a life insurance policy is typically much less than amount of reserve cash necessary to fully fund the purchase of a share of the business (and cash payable under the policy is generally more than premiums paid allowing for purchase of the business interest using less cash than the full purchase obligation amount). Only way of Guaranteeing Event that Creates need for Cash (death) also provides Cash for it: The death of a stockholder/partner can strain business from associated loss of revenue, operational disruption etc., and making it difficult to obtain loans or other funding to pay the buyout price. Using life insurance to fund the buy-sell can assure availability of cash to purchase deceased owner s interest, and eliminating need to obtain financing at time of event (which may not otherwise be obtainable at all). Policy Cash Values may be used to Fund a Lifetime Sale: When buy-sell is funded with a permanent (cash value) life insurance policy, accumulated cash values may be accessible to fund a lifetime sale resulting from retirement or disability; policy can remain in force or be surrendered when cash is required. 6

33 (Cont d) Funding Buy/Sell Agreements Through Life Insurance Life insurance proceeds paid quickly after death and quick closing in buy/sell transaction can follow (and use of insurance proceeds can provide ability for estate of deceased owner to quickly satisfy associated state and federal estate obligations). Life insurance proceeds generally received income-tax free: Such proceeds generally are not considered taxable income to policy beneficiary when beneficiary(ies) is an S corporation or the individual shareholders/partners [NOTE: a C corporation may be subject to the alternative minimum tax upon C-corp s receipt of life insurance proceeds] Simple to explain and implement: Most understand concept of life insurance, and the process for obtaining life insurance to fund a buy-sell is no different from process of obtaining any other life insurance policy 7

34 (Cont d) Funding Buy/Sell Agreements Through Life Insurance Other Considerations When Funding a Buy/Sell Through Life Insurance: What if insurance proceeds are less than the value of the subject business interest? This could be the case due to growth of the business, an increase in applied industry valuation multiples or a variety of other reasons. The Buy/Sell provisions need to clearly spell out what happens when the subject business interest is greater than the insurance proceeds, whether through installment payments, capital calls of the other stockholders/members to fund the shortfall etc. There are numerous ways this can be handled, but make sure you have identified its possibility to your client(s) and appropriately drafted for it in the Buy/Sell Agreement. What if insurance proceeds are greater than the value of the subject business interest? This could be the case if, applying the valuation mechanism in the Buy/Sell Agreement, the value of the interest is less than the insurance proceeds at time of death or because of a cash build-up in the policy (the customary way of handling this would be to draft provisions that return the excess upon the event trigger to the party(ies) that paid the premiums of the policy, and in other instances the parties may simply agree in the Buy/Sell provisions that the excess is nonetheless paid to the deceased family s estate). The key is to contemplate the issue and clearly address it in the agreement in a manner acceptable to the company/partnership, stockholders and/or partners involved. Provide in the Buy/Sell Agreement how the Business (and accordingly, the Subject Business Interest) is to be Determined: Independent Appraisal? Multiple of EBITDA or Other Similar Financial Metric etc.? 8

35 Funding Buy/Sell Agreements Through Loans or Other Sources Through Loans: Don t bank on it (especially in this still fairly dismal credit environment) Most co-owners do not have and could not easily borrow the cash necessary to fund a buyout. It might also be hard for the business to borrow the money (what lender is likely to extent credit right after a key executive and business owner has died?) Even if the business can borrow the money, it would be forced to incur the expense of debt and interest payments and forego other capital demands Principal portion of debt repayments not deductible (neither are life insurance premiums, incidentally) 9

36 (Cont d) Funding Buy/Sell Agreements Through Loans or Other Sources Installment Payments by the Business (or Other Stockholders/Partners): No assurance or likelihood that extra future after-tax cash flow would be sufficient to afford installment payments by the business or other owners. Even if installment payments are affordable, their cost would likely be much more than the cost of insurance premiums. Promised installment payments on death, disability or retirement of co-owner(s) creates a substantial unfunded liability (weighs down corporate balance sheet and makes the business less creditworthy for other borrowing). Ability to make installment payments may depend on unrealistic growth expectations of future growth in revenues. Promise or ability to pay in this circumstance may be completely superfluous. If installment payment mechanism is agreed to, consider recommending the purchase price being paid over a period of time based on profitability of the business (thus, the payment amounts vary annually depending on profitability of the business that year and lessening likelihood of default). If installment payment mechanism is agreed to and payment amounts are tied to profitability, it still should not change the total buyout price; otherwise, the departing owner (or the owner s estate) would be rewarded or penalized for the performance of the business for a time period during which the owner is not involved in the business. The agreement should prohibit the creation of a second class of stock (or options or similar that can be construed as a second class of stock) that jeopardizes the S-election (must specifically ensure in installment sale situations that the promissory note cannot be construed as something other than straight debt that constitutes a second class of equity (which too jeopardizes S election status)) 10

37 (Cont d) Special Buy/Sell Issues Involving S-Corps and Other Entities (Cont d) S-Corp Considerations Code Section 1361(c)(5) provides a safe harbor for debt to qualify as straight debt for these purposes: The debt is evidenced by a written unconditional demand to pay a fixed amount on demand or on a specified date; The interest rate and the interest payment dates are not contingent upon profits, the corporation s discretion, the repayment of dividends with respect to common stock, or other similar factors; The debt is not convertible into stock; and The creditor is an individual, estate or trust that is a permissible S-corp stockholder. 11

38 (Cont d) Special Buy/Sell Issues Involving S-Corps and Other Entities Partnership/LLC Considerations Unlike the taxation rules for S-corporations, the taxation rules for partnerships and LLCs permit great flexibility in how items of income, gain, loss, deduction and credit arising out of business conducted by the partnership/llc are allocated among the partners/members. Capital accounts can throw a wrench into things: a typical operating agreement (or partnership agreement) requires that liquidation proceeds be distributed in accordance with the members (or partners ) positive capital account balances. A detailed discussion of capital accounts is beyond the scope of this outline, but you should work closely with the company s tax advisors to ensure compliance with the Treasury Regulations and the economic expectations of the parties. 12

39 Tag-Along and Drag-Along Rights in Buy/Sell Agreements Tag-Along (Piggy Back) Rights Tag-along or piggy back rights work to the benefit of minority stakeholders. They usually come into play only after one or more other stakeholders who want to sell their shares/interest, and who represent collectively a majority or controlling interest in the company, have first offered their shares to the minority stakeholder(s) under a right of first refusal. In many cases, the minority stakeholder(s) will not have enough money to buy out all the shares offered by the departing stakeholders. However, if the outside buyer is only interested in acquiring a majority or controlling interest in the company, the minority stakeholder will not have the benefit of being purchased by the outside buyer who is acquiring control of the company. The tag-along provision requires the outside buyer to make the same offer on a follow-up basis to the minority stakeholder(s) as a precondition to completing the transaction with the majority stakeholders, thus giving the minority interests the same opportunity to sell at the same price as the majority stakeholders have been able to negotiate for themselves. A sample tag-along rights provision is contained in the included sample provision materials, with wording for an operating agreement for a limited liability company. 13

40 (Cont d) Tag-Along and Drag-Along Rights in Buy/Sell Agreements Drag-Along (Draw-Along) Rights The corresponding right of the selling majority stakeholders to the tag-along rights are drag-along rights. They are most often found in tandem with the tag-along rights, although there is no reason why a buy-sell agreement needs to contain both provisions. (In essence, the tag-along right is a put exercisable by the minority where the majority has agreed to sell, while the drag-along rights are a call by the majority on the shares of the minority.) For the selling majority stakeholder, the drag-along or draw-along rights solve the problem presented by the difficulty of finding an outside buyer who is willing to buy control of a corporation/partnership but isn t interested in inheriting a recalcitrant minority that did not welcome the change of control. The drag-along right entitles the selling (majority) stakeholder(s) to require any minority stakeholder that has not exercised its tag-along rights to nevertheless sell in to the outside offer at the same price that is being offered to the majority. In essence, it allows the majority stakeholders that have found a willing buyer to deliver the entire company. For the selling majority stakeholders, the drag-along is by far the most effective exit strategy. Its presence, however, shifts the onus back to the minority stakeholder that does not want to sell to try to come up with sufficient funds when the right of first refusal is exercised to buy out the majority interest. (For this reason, a drag-along provision should not be included in a buy-sell agreement without being conditioned upon the prior exercise of a right of first refusal that permits the minority shareholder enough time to try to buy out the majority s interest. Without the right of first refusal, the drag-along represents essentially a right on the part of a majority owner to direct the sale of the minority s equity interest.) Because it can lead to the compulsory sale of equity interests of a recalcitrant or reluctant minority, the drag-along right represents arguably the most draconian exit strategy for stakeholders. It should also be noted that the right of first refusal coupled with a dragalong is not dissimilar in effect to the more basic and balanced shotgun buy-sell arrangement, except of course that a stakeholder need not be a majority one to trigger the shotgun buy-sell. (Although it would be possible to draft the drag-along to be exercisable by a minority shareholder alone, this would be very unusual except perhaps where the minority shareholder was a sophisticated institutional investor.) The sample provisions included with the materials include a sample drag-along clause for a limited liability company for use in an operating agreement. 14

41 Tax Considerations in Buy/Sell Agreements Income Tax Considerations Insurance premiums are not deductible whether they are paid by the company or by the entity s owners (unless they constitute additional reasonable compensation to the owner/employees, in which case the amounts are a deduction for the company and includable in the ordinary income of the owner/employees). Premium payments on company-owned policies are not taxable to the individual owners either as salary or as dividends. The general rule is that the proceeds of a life insurance policy are not subject to income taxation. IRC 101(a)(1). Therefore, whether the company or its owners receive the insurance proceeds, these would generally not be taxable. [There can be exceptions under the transfer of value rule ]. The surviving owners may have a taxable dividend/distribution if the proceeds from a company-owned policy are distributed to the surviving owners and used by them to effect a cross-purchase transaction. 15

42 Estate Tax Considerations Under a cross-purchase arrangement, the insurance proceeds will generally not be included in the insured s taxable estate. Under a company redemption arrangement, the company s incidents of ownership of the policy will not be attributed to an owner of the company (even a controlling owner) if the proceeds are paid to the company or to a third person in satisfaction of a valid business need of the company. Treas. Reg (c)(6). Therefore, if the proceeds are paid to the company, they will not be included in the deceased owner s estate even if the redemption agreement requires that the proceeds be used to redeem the estate s interest in the company. Care must be taken however, and appropriate tax advice procured, because improper structuring in these matters can lead not only to the inclusion of the proceeds in the taxable estate of the deceased, but also to double inclusion of the insurance proceeds and the value of the stock in the deceased insured s estate. 16

43 Avoiding Traps Tax Trap: If less than all of the deceased s or departing shareholder s stock in a C corporation is redeemed by the corporation, it is possible that the proceeds of the redemption will be treated as dividend income in the hands of the departing shareholder or the deceased shareholder s estate (with the adverse tax consequences of ordinary income treatment). In determining whether there has been redemption of all of a deceased or departing shareholder s shares, however, IRC 318 imposes constructive stock ownership rules that (subject to certain exceptions) deem any remaining shares in the hands of spouses, children, grandchildren, parents and certain trusts and other entities to be shares of the departing shareholder that have not been redeemed (and thus potentially resulting in tax at ordinary income on the shares that have been redeemed). Drafting Traps: Ensure appropriately defined trigger terms (removal for Cause, Disability ), as well as poorly drafted and open ended valuation terms (i.e., revenues, profits and other general valuation terms that fail to take into account all the specifics ) (failure to account for economic considerations, i.e., restoration of capital account vs. distributions based on respective percentage interests which have implications on the net buyout payment figures and values). Shot Gun Buy/Sell Trap: Consider specifying exact expectations if offeree elects to accept offer to put its interest versus accepting offer to buy the offeror s interest (in reality, it is not usually as simple as decision to offer/accept on precisely the same terms). 17

44 Dispute Resolution Provisions Consider an Alternative Dispute Resolution Mechanism for Accounting, Valuation and Purchase Price Determination Related Issues Analogous to a purchase price or working capital adjustment in an M&A transaction Allows for determination by an accountant or other financial professional skilled with valuation and buyout related issues If acceptable to all parties and there is trust in neutrality, consider the firm s outside firm of certified public accountants (will be particularly familiar with capital account balances in partnership/llc situations) Not based on an independent review but instead only on the parties submissions Proportionate sharing of arbitrator (refers to whoever is making the determination, including accountant etc. in this instance) Access to books and records of company/partnership Delineate ability to raise legal claims outside of the pricing/valuation/accounting issues (i.e., you don t want the accountant making final determinations around fiduciary duty concerns etc.) 18

45 EXHIBIT A: S CORPORATION TRANSFER RESTRICTIONS SECTION 9 S Corporation Issues The provisions of this Section apply whenever the Corporation operates under an S Election Protection of Election. In addition to any other restrictions contained in this Agreement, the Corporation's bylaws, or elsewhere, the following additional restrictions shall apply in order to protect the Corporation's S election: No Stockholder may Transfer any of his or her shares of the Stock to any person if such Transfer may reasonably be expected to result in a termination of the Corporation's S Election Such prohibited Transfers include, but are not limited to: The Transfer of any such shares to a partnership, corporation, nonresident alien individual, estate (other than the estate of the Stockholder himself or herself) or trust (other than a trust that, under the Code, may hold S corporation stock without terminating an S Election); The Transfer of any such shares to a person if such Transfer will increase the number of Stockholders to more than the maximum permissible number of Stockholders of an S corporation (presently, seventy-five (75)); and The pledge or other Encumbrance of any shares of the Corporation's stock with respect to any loan from any person or entity if it reasonably could be believed that a Transfer of such shares to such secured lender would violate the restrictions of this Section No attempted Transfer or Encumbrance of any shares of the Stock in breach of the provisions of this item be valid or recognized on the Corporation's books Any Stockholder who believes that an attempted Transfer or Encumbrance of any shares of the Corporation's Stock is invalid under this Section 9.1 may request from the Corporation an opinion on the application of this Section. Such request shall be made by a written notice to the Corporation's President, setting forth the details of the proposed Transfer or Encumbrance and the reasons why the Stockholder believes it to be invalid. the Corporation's President shall promptly thereafter request a written opinion from the Corporation's counsel (who may be an employee of the Corporation or independent outside counsel) and such written opinion shall be binding on the Corporation and on all Stockholders The Corporation may assess against any Stockholder who attempts any such invalid Transfer or Encumbrance a fee to cover its expenses plus two thousand dollars

46 ($2,000.00) in evaluating whether or not a Transfer or Encumbrance is invalid under this Section No Stockholder may Transfer any shares of the Stock of the Corporation if that Transfer may reasonably be expected to result in an Impermissible (as defined below) number of persons holding the shares of the Stock held by the Transferor immediately prior to the Transfer. A number of persons holding shares of the Stock is "Impermissible" if it is in excess of a number calculated by multiplying the maximum permissible number of Stockholders of an S corporation (presently, thirty-five (35)), by a fraction, the numerator of which is the amount of the Transferor's shares of the Stock (determined immediately prior to the Transfer) and the denominator of which is the total number of issued and outstanding shares of the Stock Any Stockholder who is a U.S. citizen not residing in the United States and who ceases for any reason to be a U.S. citizen, and any Stockholder who is not a U.S. citizen who ceases to be a resident of the United States, shall be deemed to have offered to sell all of his or her shares of the Stock to the Corporation for the Agreed Terms. The Corporation shall be deemed to have accepted such offer and such shares shall be canceled and shall become Treasury stock of the Corporation. Such cancellation shall be effective on the date immediately preceding the date of such Stockholder's change in citizenship or residency Any Stockholder who files or on whose behalf is filed any voluntary petition in bankruptcy or against whom is filed any involuntary petition in bankruptcy, under applicable federal or state law, and any Stockholder who attempts to use any provision of federal or state bankruptcy acts, or who attempts to assign any assets for the benefit of creditors, shall be deemed to have offered to sell all of his or her shares to the Corporation for the Agreed Terms. The Corporation shall be deemed to have accepted such offer, and such shares shall be canceled and shall become Treasury stock of the Corporation. Such cancellation shall be effective on the date immediately before the date on which such petition was filed or such Transfer was attempted Any Stockholder who takes any action, does anything or fails to take any action or do anything, the result of which would otherwise be to cause the Corporation's S Election to be terminated involuntarily, and who can take any action that would cure such defect and preserve the Corporation's S Election, shall take such curative action and do such things as may be required to preserve the Corporation's S Election. Any Stockholder who believes that an action taken or not taken or a thing done or not done by another Stockholder will cause the Corporation's S Election to be terminated involuntarily and further that there may be an action that can be taken to cure such defect and preserve the Corporation's S Election, may request from the Corporation an opinion on the application of this item Such request shall be made to the Corporation's President by a notice in writing, setting forth the details of the action or inaction which the Stockholder believes jeopardizes the Corporation's S Election and the action that may cure such defect and preserve the Corporation's S Election. The Corporation's President shall promptly thereafter request a written opinion from the Corporation's counsel (who may be an employee of the Corporation or independent outside counsel) and such written opinion shall be binding on the Corporation and on all Stockholders. If it is the opinion of the Corporation's counsel that the questioned Stockholder action or inaction may indeed jeopardize the Corporation's S Election, then the Corporation shall assess against the Stockholder who has done

47 such act a fee to cover its expenses plus two thousand dollars ($2,000.00) in evaluating whether or not such action jeopardizes the Corporation's S Election and what curative steps may be taken. The opinion of the Corporation's counsel as to the curative steps that may be taken shall be conclusive on all parties Every stockholder agrees to take such actions, as a Stockholder, director, officer, or otherwise, to preserve the Corporation's S Election and to preclude the Corporation from doing anything that could reasonably be expected to result in the termination of its S Election. Any Stockholder who believes that a contemplated action of the directors or officers of the Corporation would jeopardize its S Election may request an opinion on the application of this Section from the Corporation. Such request shall be made to the Corporation's President in writing, setting forth the details of the proposed action and the reasons why the Stockholder believes such action to jeopardize the Corporation's S Election. the Corporation's President shall promptly thereafter request a written opinion from the Corporation's counsel (who may be an employee of the Corporation or independent outside counsel), and such written opinion shall be binding on the Corporation and on all Stockholders. The Corporation shall pay all costs of obtaining such opinion, unless it can be shown that the person requesting such opinion acted in bad faith, in which case all actual costs of such opinion shall be assessed against the person requesting it If, notwithstanding the provisions of this Section, any Stockholder's Encumbrance, Transfer, vote as a director or officer, or other action results in or contributes to the termination of the Corporation's S Election, such Stockholder shall be liable to the Corporation for liquidated damages Such liability for liquidated damages shall exist on a "no fault" basis, regardless of whether such Stockholder's termination of the Corporation's S Election was caused by acts which were intentional, unintentional, with or without malice or bad motives The liquidated damages shall be an amount equal to fifty thousand dollars ($50,000). Neither the Corporation nor any of its Stockholders shall have any duty to mitigate damages with respect to the termination of the Corporation's S Election by the act of one (1) or more of the other Stockholders Dividends. To minimize the hardship that might be caused by the direct taxation of the Corporation's net profits to its stockholders, the Corporation's Board of Directors shall be deemed to have voted annually to have the Corporation pay to the Stockholders as dividends for each of the Corporation's taxable years the percentage of the increase in the Corporation's accumulated adjustments account for any such year (as determined for federal income tax purposes) that is the five percentage points (5%) above the highest federal income tax rate bracket imposed on ordinary dividend income Termination. Nothing in this section shall restrict the right of all of the Stockholders acting together and by written instrument, to terminate the Corporation's S Election, and no damages shall be due to the Corporation or to any Stockholder on account of such termination.

48 EXHIBIT B: Tag-Along and Drag-Along Rights for an LLC 1.1. Right to Participate in Certain Sales. [Tag-Along Rights] (a) If one or more Members holding together a majority of the Sharing Ratios held by all Members (the "Majority Members") desires to Transfer, directly or indirectly, their Interests (or portions thereof equal in the aggregate to such majority) owned by it to any Third Party in compliance with above (any such Transfer being referred to herein as a "Tag-Along Sale"), the other Members (the "Other Members"), [including any Member or Permitted Transferee of a Member who is obligated to sell his, her or its Interest to the Company pursuant to hereof but who has not yet Transferred such Interests at a closing pursuant to Section (an "Obligated Member")], shall have the right, but not the obligation, to participate proportionately in such Tag-Along Sale by selling the Interests in the Company owned by them on the same terms and conditions as the proposed Tag-Along Sale by the Majority Members, as set forth below. [The determination of any Member or Permitted Transferee of a Member to participate in any Tag-Along Sale pursuant to this Section 6.1(a) shall supersede all rights granted to any Person pursuant to hereof.] [Note: The other section referenced could be, for example, a buy-out from an employee member of his interest upon termination.] (b) The Majority Members shall provide each Other Member with written notice (a "Tag-Along Sale Notice") at least 30 days prior to such Tag-Along Sale. Such Tag-Along Sale Notice shall set forth (i) the name and address of the proposed transferee of the Interests in the Tag-Along Sale; (ii) the proposed amount and form of consideration to be paid for such Interests and the terms and conditions of payment; and (iii) that the proposed transferee has been informed of the "tag-along rights" provided for in this Section and has agreed to purchase the Other Members' Interests in accordance with the terms thereof. (c) Each Other Member who wishes to participate in the Tag-Along Sale shall provide written notice (the "Tag-Along Acceptance Notice") to the Company and the Majority Members within 20 days of the date that the Tag-Along Sale Notice is received by such Other Member. The Tag-Along Acceptance Notice shall set forth the amount of Interests owned by such Other Member, and the fact that such Other Member wishes to participate proportionately in the Tag-Along Sale. (d) If a Tag-Along Acceptance Notice is not received by the Majority Members from an Other Member within the 20-day period specified above, the Majority Members shall have the right to Transfer the Interests owned by the Majority Members to the proposed purchaser without any participation by such Other Member, but only on the terms and conditions stated in such Tag-Along Sale Notice (or on terms and conditions no more favorable to the transferor) and only if the shares are Transferred no later than 30 days after the end of such 20-day period specified above.

49 1.2. Right to Compel Sale. [Drag-Along Rights] (a) If the Majority Members propose to Transfer all of their Interests to any Third Party, in one or in a series of transactions in compliance with above (a "Go-Along Sale"), then the Majority Members, together, at their option, may require all other Members [(including any such holder who is an Obligated Member)] (the "Other Members") to sell all the Interests owned by them for the same consideration per [Percentage Interests/Sharing Ratios] and otherwise on the same terms and conditions as the Majority Members sell their Interests in the Go-Along Sale. [The determination of any Member or Permitted Transferee of a Member to be required to participate in a Go-Along Sale pursuant to this Section shall supersede all rights granted to any Person pursuant to Article hereof.] [Note: The section referred to in the last sentence above could be any other provisions of the buy-sell/operating agreement that grant puts, calls, etc. Probably any rights triggered by death or dissociation events (e.g. termination of employment) should not be referenced, but should continue to be paramount over the drag-along rights.] (b) If the Majority Members determine to exercise their rights under Section (a) above, they shall provide each Other Member and their Permitted Transferees, if any, with written notice (a "Go Along Sale Notice") at least 30 days prior to such sale. Such Go-Along Sale Notice shall set forth (i) the name and address of the proposed transferee or purchaser in the Go-Along Sale, and (ii) the proposed amount and form of consideration to be paid for such Interests and the terms and conditions of payment. (c) In the event that any Member should fail to transfer such Member's Interest to the purchaser in accordance with the terms of the Go-Along Sale, the Company shall cause the books and records of the Company to show that such Interest is bound by the provisions of this Section and shall be Transferred only in accordance with the Go-Along Sale.

50 $^ ^, Colorado EXHIBIT C: Form of Promissory Note for Purchase Price PROMISSORY NOTE ^, 20^ FOR VALUE RECEIVED, THE UNDERSIGNED promises to pay to the order of ^ the principal sum of ^ Dollars ($^), together with interest on the unpaid balance of said principal sum at that fluctuating rate of interest determined from month to month by the U.S. Secretary of the Treasury to be the applicable Federal mid-term rate pursuant to Section 1274 of the Internal Revenue Code, or any successor to such Section, in 60 equal, consecutive monthly installments of principal in the amount of $^ each, payable commencing on and accruing from the first day of ^, 20^, and continuing on the first day of each and every month thereafter until said principal sum and all interest accrued thereon shall have been paid in full. All payments of principal and interest shall be made at ^, or at such other place as may be designated by the holder hereof. The amount of each installment or other payment made under this Note shall be applied first to interest due and payable, and the balance, if any, of each such installment or other payment shall be applied toward reduction of the outstanding principal sum of this Note. If any monthly installment of principal and interest or principal or interest is not paid within 10 days when due, it shall bear and accrue interest at the rate of 15% per annum from and after the 10th day after the due date. The undersigned shall have the right to prepay the whole or any part of this Note at any time and from time to time without premium or penalty, provided that with each such prepayment accrued interest to the date of such prepayment is paid. Any and all such prepayments shall be credited against the installments last due under this Note

51 Repayment of the indebtedness evidenced by this Note is secured by the Pledge Agreement (the Pledge Agreement ) of even date herewith between the undersigned and the payee hereof. The undersigned shall be in default hereunder upon the occurrence of any one or more of the following events: (a) The non-payment when due of principal and interest or principal or interest as provided in this Note and such non-payment shall not be cured within 10 business days following receipt by the undersigned of written notice from the holder hereof of such non-payment. (b) If the undersigned shall be in breach of or in default under the Pledge Agreement. (c) If the undersigned (i) applies for or consents to the appointment of, or if there shall be a taking of possession by, a receiver, custodian, trustee or liquidator for the undersigned, or any material part of his property, (ii) makes a general assignment for the benefit of creditors or becomes insolvent, or (iii) files or is served with any petition for relief under the Bankruptcy Code or any similar federal or state statute, and if so served, shall not cause such petition to be dismissed within 120 days of such service. Upon a default hereunder, the entire unpaid principal balance hereof and interest accrued and unpaid thereon shall, at the option of the holder hereof exercised by written notice to the undersigned, become immediately due and payable. The undersigned hereby waives presentment for payment, demand, protest or notice of protest or of dishonor. If this Note is forwarded to an attorney for collection after maturity hereof (whether by declaration, acceleration or otherwise), the undersigned shall pay all costs and expenses of collection, including, but not limited to, reasonable attorneys fees. Each right, power and remedy of the holder hereof as provided for in this Note or now or hereafter existing at law or in equity or by statute shall be cumulative and concurrent and shall be - 7 -

52 in addition to every other right, power or remedy provided for in this Note or now or hereafter existing at law or in equity or by statute, and the exercise or beginning of the exercise by the holder hereof of any one or more of such rights, powers or remedies shall not preclude the simultaneous or later exercise by the holder hereof of any or all such other rights, powers or remedies. No failure or delay by the holder hereof to insist upon the strict performance of any term, condition, covenant or agreement of this Note or to exercise any right, power or remedy consequent upon a default hereunder shall constitute a waiver of any such term, condition, covenant or agreement or of any such breach, or preclude the holder hereof from exercising any such right, power or remedy at any later time or times. By accepting payment after the due date of any amount payable under this Note, the holder hereof shall not be deemed to waive the right either to require payment when due of all other amounts payable under this Note, or to declare a default for failure to effect such payment of any such other amount. This Note is made in, and shall be governed by, construed and enforced in accordance with the laws of, the State of Colorado. Wherever used in this Note, the singular shall include the plural and vice-versa, and the use of any gender or the neuter shall include all genders and neuter. IN WITNESS WHEREOF, the undersigned has executed and delivered this Note on the day and year first hereinabove set forth