Mercer Capital:  “Promissory notes are used frequently as a funding mechanism when buy-sell agreements are triggered.  However, most buy-sell agreements reflect very little thought or negotiation regarding the promissory notes that they contain. . . . Promissory notes issued pursuant to the operation of buy-sell agreements are fairly common and often do not provide equivalent fair market value for the stock that is sold by shareholders. This raises a number of issues:

  • For companies.  The promissory note found in your buy-sell agreement may provide flexibility to the company if and when issued in a transaction.  However, the question remains, is it “fair” and reasonable for all shareholders?
  • For shareholders who remain after a transaction.  You will benefit from the repurchase with favorable (to the company) financing for the purchase.  That’s positive, perhaps.
  • For the selling shareholder.  Selling shareholders do not receive what they bargained for, i.e., the fair market value of their stock when sold at a trigger event.  That’s certainly not positive from their perspectives.
  • For all shareholders.  There is risk here since no one knows in advance who will be the selling shareholder.
It is a good idea to look at the promissory note in your buy-sell agreement (or your clients’ buy-sell agreements) to determine if it is reasonable for all the parties under reasonably foreseeable circumstances.”