Getting Out of Closely Held Corporations: Put Rights and Rights of First Refusal

Jul 16, 2018 | Business

Shares in a closely held corporation are typically not marketable. Very few investors want to become a shareholder in a closely held corporation. This creates the problem of determining how a shareholder can get out of a closely held company at a fair price. One way to deal with this problem is a put right along with a right of first refusal.

A put right is the right to sell shares to the other shareholder. A put right is created by the shareholder agreement. This is how it works:

    1.  The shareholder offers to sell her shares to the other shareholder for $X.XX per share.
    2.  If the other shareholder does not agree to the price, an appraisal of the business is done and the share price is set.
    3.  After the appraisal, both shareholders 30-90 days to accept the price per share and close the purchase.
      If either shareholder rejects the price, then other shareholder is free to sell her shares to whoever she wants to sell them to.

Along with the put right, most shareholder agreements also have a right of first refusal. If shareholder finds a buyer for her shares, she signs an agreement that states the price of the shares and the amount earnest money paid. Under the right of first refusal, she must offer the same deal to the other shareholder. The other shareholder has 30-90 days to accept the same deal or the selling shareholder is free to sell her shares to her buyer.

The practical effect of these two clauses is the selling shareholder can not demand an above market price for her shares to the other shareholder, then turn around and sell them to a third party at a better price. In both cases, the other shareholder gets the chance to buy the shares.

This is a clause setting out the put right and the right of first refusal that could be incorporated into a shareholder agreement.

X.X Put Right. Shareholders grant to one another the right to put some or all of our respective shares to the other at any time and upon the terms set forth herein. The right to purchase such put shares shall be exercised within 90 days of written notice of the put. The word “exercise” means actual purchase of the shares.

X.X.X Put Share Price. The price of such put shares shall be negotiated. If Shareholders cannot agree as to the price of the shares, Shareholders agree to obtain a business appraisal to determine the fair market value of the shares and such value shall be the price of the shares. The appraisal shall be paid for by the Company. The option period shall toll during the appraisal period.

X.X.X Right of Refusal. If Shareholders cannot agree to an appraiser or means to fairly appraise the value of the shares or a shareholder declines to purchase at the appraised value, then the transferor may freely convey its shares EXCEPT the remaining shareholder(s) shall then have a right of refusal at the price offered to a subsequent transferee. Such price shall be evidenced by an executed purchase and sale agreement supported by earnest money. The remaining shareholder(s) shall have 60 days from receipt of said purchase and sale agreement to exercise his option or be forever barred. The word “exercise” means actual purchase of the shares.

X.X Transferee Bound. A transferee shall take such shares subject to this agreement.