by Robert Wenzel
Oftentimes in business, one or more of the owners wants or needs out. While this can create potential problems, one of the methods that can protect the parties is a co-sale agreement.
Co-sale agreements are clauses that allow individuals of management to share the future sale of stock with the company investors. What this means is when someone in a management position chooses to get rid of their shares, the investor has the option of selling their shares at the same time.
When a co-sale agreement occurs, the person who is selling their stock shares has to inform the investors of the sale and the terms of the deal. At that time, the outside person providing financing have the opportunity to sell their shares to the person making the purchase. If the investor chooses to sell a portion of their shares, then the member of management would reduce their shares being sold. This allows the person who is buying the shares to purchase the amount that they initially agreed to.
Co-sale agreements have many advantages. One reason why companies have this provision is to prevent management members from turning a large profit on their sale and leaving any liabilities to the investor. This can help the individual providing the capital from having to absorb a loss and not be able to recoup a profit on their investment. Further, it prohibits individuals in management from only watching out for their own financial benefit at the expense of the investors. By the same token, the co-sale agreement can also help to promote a new influx of money into the company, especially when it may be needed the most.
In addition, having a co-sale provision also requires both the outside investor and the individual in management to disclose as much information to the person who may be buying the stock. This is beneficial because the potential new investor can gain a better idea of the stability of the company without making a financial commitment. At the same time, management and the investors need to be as forthcoming as possible about the company.
However, one topic that management may want to discuss is having a cap as to the number of shares that can be sold within a certain time period. If there is a limit as to how much can be sold, it could potentially avoid additional shares being disposed of out of potential fear. Also, when a large number of shares are sold, possible new investors may be weary of giving capital to the company.
Here is an example of how a co-share agreement may benefit all sides and avoid problems: Two individuals decide to open up a gas station. The partners decide that they need to accept outside money to get their business up and running. One of the investors who provides money is married. At the time that the capital is accepted, no co-share agreement is drafted or agreed upon. After a couple of years, the business is going well and the individual who gave the money wants to sell their shares of the company for a profit. However, the investor and his spouse are now divorced.
This can create a wide range of problems. To begin with, the non-investing spouse may claim that he or she owns a part of the business since the capital was provided to the start-up company during marriage. This spouse may also state that they are entitled to a portion of the investment profits.
With a co-share agreement in place, however, the agreement can state what the terms of the sale will be. The terms can state if the spouse making the claim has any right to the capital return, and if so, how much the return would be. The business operators can also avoid trying to sell the business for a profit and leaving any losses to the spouses. Further, the co-sale agreement may even allow for the two partners to buy out the investor, which could eliminate any issues with the couple who are involved in the divorce.
Before deciding to pursue a co-share agreement, it is always a good idea to discuss both the positive and negative aspects with the company’s management team, which may include a board of directors. Having a wide range of ideas can help to stimulate dialogue and what option may be best for the company and any current (or future) money coming into the organization. Further, consulting with an attorney (such as a business in-house counsel or a business attorney) may help the company evaluate what would be most favorable to all involved parties.