Buy-Sell Agreements: Stability in a Time of Uncertainty

Estate Planner May-Jun 2000

Retirement doesn’t have to be right around the corner before you plan for it. Have you considered how your stake in your company will be handled when you retire? What if you were to die before retirement? Will your family be forced to negotiate the sale of your interest? A buy-sell agreement can help circumvent many business transition problems and stabilize what could otherwise be difficult periods of uncertainty.

What Are Triggering Events?

A buy-sell agreement is a popular tool to transfer a stake in a business upon the occurrence of a predefined event called a triggering event. Some triggering events include:

  • Death,
  • Disability,
  • Retirement,
  • Bankruptcy,
  • Divorce,
  • Voluntary or involuntary termination of employment, and
  • An involuntary sale of stock.

After the triggering event occurs, the buy-sell agreement dictates the sale according to the agreement’s terms. The agreement specifies, among other things, who will buy the stock and at what price. (Although we are discussing the sale of stock, a buy-sell arrangement applies equally to interests in partnerships and limited liability companies.)

Both your business and your family benefit from a properly designed buy-sell agreement. For example, at your death, a buy-sell agreement will reduce much of your family’s economic uncertainty. Without the agreement, difficult negotiations could ensue between your family members (who may have an unrealistic view of the company’s value) and surviving shareholders.

Buy-sell agreements also help preserve the surviving shareholders’ control of the company by restricting stock transferability and controlling who may become shareholders. An orderly transition can help prevent the business from being dissolved in a distress sale caused by internal dissent.

Stock in a closely held business is generally an illiquid asset, but the buy-sell agreement can provide your estate with sufficient cash to pay:

  • Death taxes,
  • Debts and administration costs, and
  • Support and living allowances for family members.

Furthermore, during your lifetime, you hold the best bargaining position to maximize the purchase price. Family members generally do not have sufficient knowledge of the business or leverage to exact the best possible offer from the corporation or other shareholders. And obtaining a predetermined value for your stock can offer certain federal estate tax benefits because in some cases your stock may be given a lower valuation for estate tax purposes.

Types of Buy-Sell Agreements

The buy-sell agreement is generally structured as either a stock redemption or a cross purchase. Here’s a closer look at each:

Stock redemption. Stock redemption allows the business to use its funds to buy your stock. Life insurance commonly funds the company’s purchase of the shares when you die. The stock redemption structure assures that the premiums are paid on time, giving you peace of mind. If insurance funds your stock purchase, the stock redemption approach could also alleviate some administrative burdens not covered with a cross-purchase structure. Though the stock redemption structure is easier to administer, the cross-purchase structure can lower the overall tax burden.

Cross purchase. Surviving shareholders buy back your stock at your death under a cross-purchase buy-sell agreement. The arrangement is almost as if your shares are pieces of a pie. When one shareholder experiences a triggering event, the others must buy his or her shares. While it seems simple, it’s not. The cross-purchase agreement places unequal financial burdens on newer or younger shareholders. For example, a 10% shareholder may be required to purchase a 90% shareholder’s interest.

You can create a hybrid agreement if you are not sure which structure best suits your needs. The hybrid agreement gives the corporation the option to buy the stock. If the corporation’s option expires, then the shareholders are either given the option to buy the stock or are required to buy it. This arrangement allows the parties to determine the best structure at the most opportune time.

Which Buy-Sell Agreement Is Best for You?

If you think a buy-sell agreement may be useful to you, please contact us. Our professionals would be happy to discuss your business situation to arrive at the solution that fits your needs.