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A buy-sell agreement refers to an agreement between shareholders which provides for the orderly transfer of ownership shares after a triggering event such as the retirement, death or disability of a shareholder. The buy-sell agreement can allow for either the optional or the mandatory sale or purchase of shares.

Types of "triggering events"

Triggering events can include: retirement, death, disability, divorce, termination of employment, business disagreement, or personal bankruptcy.

Purpose of the buy-sell agreement

If the owners have only verbal agreements regarding transfer of ownership, there can be disagreements after a triggering event arises. A written buy-sell agreement not only documents the agreements, but also requires the owners to discuss and agree upon the relevant issues before the triggering event -- and thus before there are vested interests in specific outcomes.

Examples of undesireable outcomes

Buy-sell agreements can help to prevent outcomes which may be undesired by shareholders such as:
  • Shares being sold to outside parties
  • Divorced spouses or the spouse of a deceased partner becoming an owner
  • Disagreements about the value of the business when a purchase of shares is triggered by the buy-sell agreement
  • Disagreements about the terms of purchase of the shares
  • Inadequate planning for methods to purchase the shares when necessary (i.e., methods to fund the buy-sell agreement)
  • Needing to sell the business in order to pay estate taxes

The role of life insurance and disability insurance

Life insurance and disability insurance are often used to fund the buy-sell agreement. This assures that money is available to purchase the shares as intended while paying relatively affordable premiums.

Estate tax implications

For family businesses where the owners wish to pass ownership to the next generation, a buy-sell agreement can create a conservative valuation formula which thus reduces the taxable value of the shares which are transfered.

The need to modify the buy-sell agreement over time

As circumstances change, e.g., adult children entering the business, the buy-sell agreement frequently needs to be updated to reflect the changing circumstances.

References


Further reading and external links


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Categories: Succession of ownership