What Is the Purpose of a Buy/Sell Agreement?

Buy/sell agreements are used to ensure that transfer of a business interest is well coordinated.

What Are the Types of a Buy/Sell Agreement?

There are two major types of buy/sell agreements including:

  1. Agreements that specifically limit the transfer of shares.
  2. Agreements that restrict the shares transfer as well as prescribe the value of shares for estate tax considerations.

What Information Should the Buy/Sell Agreement Include?

A buy/sell agreement typically specifies:

  • The type of agreement.
  • Trigger events that result in an optional or compulsory buy-out.
  • A clear definition of the valuation date according to the provisions of the agreement.
  • A standard selling price and the payment modalities.
  • Sources of financing the agreement.
  • Noncompete agreements between the contracting parties.
  • Transfers of an owner's business interests which the agreement permits.
  • Transfers which the agreement prohibits.

Advantages of Having a Buy/Sell Agreement

Here are some of the major benefits of a buy/sell agreement:

  • It ensures the continuity of the business in the event of the death, disability or retirement of its owners.
  • Provide buyers for the stocks of the company which may have been difficult to sell.
  • Ensures that the control of the business continues to be closely held or in the hands of people chosen by the owners.
  • Provides funds to the estate of shareholders upon their demise for funding estate costs and taxes.
  • Provide financial support for a deceased shareholder's family from the proceeds of the sale.
  • Provides enough liquidity for a fair market value exchange.
  • Ensures equitable and coordinated transfer of ownership, management and wealth.
  • Provides tax benefits.
  • Provides buyers for heirs' assets which they may not be able to manage.
  • Provides heirs money to settle debts, taxes, and expenses.

Disadvantages of Not Having a Buy/Sell Agreement

In the absence of a well-planned buy-sell agreement, the business may run into murky waters after an important owner's death, retirement or disability.

Disadvantages of a Buy/Sell Agreement

A buy/sell agreement can have the following disadvantages:

  • The money used to finance the life insurance which is the cornerstone of a buy/sell agreement reduces the funds available for business activities and the personal expenses of shareholders.
  • After signing the buy/sell agreement, the provisions of the contract may not be favorable for purchases of the interests of a shareholder.
  • A buy/sell agreement may also prevent the time extension allowed under Section 6166 for the payment of estate taxes regarding closely held business ownership.
  • It can also prevent the deduction for eligible family-owned business interests under Section 2057.
  • It may prevent applying Section 2032A rules of special-use valuation.
  • A buy/sell agreement may restrict the use of family limited partnerships and related methods which offer valuation discounts.
  • Additionally, the business owners may discover that the company could get a better price for the stocks if it were sold when the owner was still alive, rather than after their demise.

What Information Should the Buy/Sell Agreement Include?

The agreement details the events which will occur for the interests of the company's shareholder to be sold or offered for sale to other shareholders or the company. The events typically include death, disability, and retirement of a shareholder, but can also include situations such as divorce, bankruptcy, or losing the legal or professional right to be a member of the company.

Who Are the Purchasers in a Buy/Sell Agreement?

A buy/sell agreement has two potential buyers including:

  1. The company can buy the stock under a stock redemption agreement.
  2. Other stockholders can buy the stock under a cross-purchase agreement.

What Should Be Considered When Forming a Buy/Sell Agreement?

Before forming a buy/sell agreement, the business entity and its shareholders should carefully assess the risks, benefits, and costs.

What Is the Basis for Guarantees?

Guarantees are based on the abilities of the issuing life insurance company to pay claims.

What Should Be Considered When Forming a Buy/Sell Agreement?

When forming a buy/sell agreement that will protect the interests of all owners and prevent future disagreements, the shareholders must have clear goals, understand the implications of the agreement, and available options. The rights, duties, tax considerations and financial position of every party must be covered. CPAs can provide more insights into options available to owners.

Disputes often arise due to different interpretations of provisions of buyer/seller agreements regarding the interest of owners.

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