A stock redemption agreement is a contract between a corporation and the stockholder, where the corporation repurchases the stock from the owner; one of the most common buy/sell agreements. First, a buy/sell agreement comprises a contract restricting owners from transferring ownership shares in a tightly knit business. Such a contract tends to be used as a vehicle to offer an orderly and planned transfer of a business interest. The agreement can be used in the following forms:

  1. Partnership
  2. Corporation
  3. Limited liability company

Shareholders within a close corporation may wish to instill a stock redemption agreement for the following reasons:

  1. To offer business continuity if disability, death, or retirement of a member occurs
  2. To create a market for close corporate stock that would be hard to sell otherwise
  3. To make sure that ownership of the corporation remains with people that were chosen by current owners
  4. To offer liquidity to the estate of a shareholder who is deceased to compensate for a decedent’s estate costs and taxes
  5. To support the family of a deceased owner from any proceeds of the close corporate sale of the stock

Disadvantages of Buy/Sell Agreements

One of the most common disadvantages of a buy/sell agreement is the cash paid regarding premiums on the life insurance of the shareholder. The life insurance (which is usually used to fund the buy/sell agreement) is not available for payment of close corporation investment and expenses. Moreover, it issues distributions to shareholders.

The agreement also notes that shareholder stock would be sold (or offered for sale, at the very least) to other stockholders. This could also apply to the close corporation during a certain event. Such an event can come in the form of retirement, death, or disability. With that, such occurrences may also entail instances that include the following:

  1. Divorce
  2. Personal bankruptcy
  3. Incapacitation

The buy/sell contract may also be created as a right to first refuse if a shareholder wishes to sell the close corporation stock

Types of Agreements

You should be aware of the three types of stock buy/sell contracts:

  1. Cross-purchase contracts
  2. Hybrid agreements
  3. Redemption agreements

Stock Redemptions

When it comes to stock redemptions, it benefits the shareholders because the contract essentially buys out the shareholder. The contract also allows you to detail the terms regarding the transfer or purchase of the shares. The redemption agreement usually grants a close corporation the right of first refusal if an offer from a third party exists. This is a common arrangement in many close corporations for the following reasons:

  1. For the sake of a disabled or deceased shareholder
  2. A shareholder has been terminated from the company

If you have more than two stockholders, especially when disability or life insurance is designed to fund a buy/sell agreement, such buyouts are arranged in the form of stock redemption, which is paid through corporate funds.

When the buy-out occurs, the shares are brought back into the business, but are then rendered in the unissued category. There are times when shares are known as treasury stock within the corporation. A redemption is a good way to get rid of certain shareholders in a company, while preserving ownership among the remaining stockholders. If a stock redemption contract gets funding from a life or disability insurance policy, the company would pay the premiums. In addition, the close corporation would own the policy, and the business would be the beneficiary.

Premium Costs

The costs of the premiums are divided in proportion by all shareholders. This is because the business takes responsibility for all the payments. Also, young shareholders, or those with few shares, do not have to pay large insurance premiums to cover older stockholders and other stockholders who own additional shares.

The administration of such a buy/sell contract is rendered easier because there is only a single policy for every stockholder. Moreover, the legal contract may be drafted as a single agreement. Stock redemption payments that deal with non-liquidated corporate distributions could result in taxable divides for a shareholder recipient.

This could happen if a transaction does not qualify as a properly sold stock, according to IRS guidelines. With that, if shareholders retain a large amount of capital losses from other business transactions, the sale treatment is the ideal solution. The capital losses can then be a method of offsetting the capital gain that’s triggered by a transaction involving stock redemption.

To learn more about a stock redemption agreement, you can post your job on UpCounsel’s website. UpCounsel’s attorneys will provide greater insight into stock agreements and how you can receive the gains of a stock redemption agreement. In addition, they may read over any stock agreement before you sign it.