Why Use A Buy Sell Agreement?
A Buy Sell Agreement, sometimes also called a shareholder’s agreement is a legally binding agreement among the shareholders (of a corporation) or interest holders (with a limited liability company) or partners (with a general partnership). The Buy-Sell Agreement places certain restrictions on the transfer of stock, membership interests, or partnership interests and may also require certain actions to be taken on defined triggering events like the death or retirement of a shareholder or partner.
Although most frequently used by s-corporation shareholders, a Buy-Sell Agreement is also well suited to fit the needs of sole-proprietors, partnerships, and single-member limited liability companies. A Buy-Sell Agreement is a critical tool in stabilizing the value of a closely held business and for transferring it under specified circumstances to the desired parties.
The nature of a closely held business (a business in which the majority shareholders (and their families) receive most of their income from the business in the form of salaries and other benefits) can cause significant problems when ownership changes because of death, disability, retirement, divorce, bankruptcy or sale to third-party. A properly drafted Buy-Sell Agreement can address what happens under these “triggering” circumstances as well as provide for methods of funding the buy-out and the tax issues associated with such buy-outs.
It can also cover the problems that arise out of special or unique issues such as when the company has elected S corporation tax treatment. In fact, only a Buy-Sell Agreement can guarantee the surviving or remaining shareholders that management and corporate control will remain with the individual or group that they have all agreed on.
Buy-Sell Agreements can take different forms and are sometimes simply provisions in other agreements (e.g., they are often found in a limited liability company operating agreement). Typically though they are stand-alone agreements that can be either cross-purchase agreements, where the surviving or remaining shareholders purchase the shares or the departing shareholder stock or interest) redemption agreements where the corporation (or limited liability company) is the purchaser.
In the typical cross-purchase agreement, on the death of a shareholder, the other shareholders would be required to purchase the deceased shareholder’s stock (or membership interests) and the estate would be required to sell it at an agreed price or according to an agreed formula.
The purchase can be funded with cash, paid for on an installment basis through a promissory note or through life insurance. With a properly drafted, properly funded Buy-Sell Agreement, the deceased shareholder’s estate gets cash and/or promissory notes and the buyers get stock (or membership interests) in return. Thus, a properly drafted and funded Buy-Sell Agreement can prevent the fire sale of the business on the death of a shareholder to pay costs associated with the death such as estate taxes.
The best time to enter into these agreements is at the outset of the business relationship, but they can be entered into at any time. Hopefully, the above is enough information to get you motivated to begin the process of developing a solid Buy-Sell Agreement. Keep in mind, the ultimate structure and funding of the Buy-Sell Agreement depends on many factors such as the number of owners or partners, the immediate and long-term needs of the business and the shareholders as well as the tax consequences.
As with all legally binding agreements, the aid of legal, tax, or insurance professionals is strongly suggested.
Author James Vignione, administrator of Orion Systems specializes in free business forms, legal forms, and business information to help people with their business and personal affairs.