A buy-sell agreement is a legal agreement between business partners or co-owners that sets forth the terms and conditions under which one or more of the owners can sell their interest in the business. Buy-sell agreements are often used in estate planning to provide a mechanism for the orderly transfer of a business’ ownership in the event of an owner’s death, incapacity, bankruptcy, or other circumstances. Buy-sell agreements can also help business owners and their families realize the value of a closely-held business in the event of the owner’s unexpected death or incapacity.
Different Types of Buy-Sell Agreements
Buy-sell agreements can take many different forms, depending on the needs and goals of the parties involved. Some common types of buy-sell agreements include cross-purchase agreements, redemption agreements, and hybrid agreements.
Cross-purchase agreements are typically used in situations where there are a small number of owners and each owner wants to buy out the other owners’ interests in the event of their death or incapacity. In a cross-purchase agreement, each owner may agree to buy the other owners’ interests at a predetermined price or formula. For example, if there are three owners and one owner dies, the surviving owners would each buy a portion of the deceased owner’s interest in the business.
Redemption agreements, on the other hand, are typically used in situations where the business itself will buy out an owner’s interest in the event of their death or incapacity. In a redemption agreement, the business may agree to purchase the owner’s interest at a predetermined price or formula. For example, if there are three owners and one owner dies, the business itself would buy out the deceased owner’s interest, rather that the three surviving owners.
Hybrid agreements combine elements of both cross-purchase and redemption agreements. In a hybrid agreement, the surviving owners have the first option to buy out the deceased owner’s interest, but if they decline, the business itself will purchase the interest.
Benefits of Buy-Sell Planning as part of Estate Planning
Buy-sell agreements can provide many benefits in estate planning. One of the primary benefits is that they provide a clear and orderly process for transferring ownership in the business. This can help to avoid disputes and ensure that the business continues to operate smoothly in the event of an owner’s death or incapacity.
Buy-sell agreements can also provide tax benefits. For example, in a cross-purchase agreement, the purchasing owners can potentially receive a step-up in tax basis with respect to the purchase price paid for the departing owner’s interest.
In addition, buy-sell agreements can help to ensure that the business remains in the hands of the individuals who are best suited to run it. For example, if one owner dies, the remaining owners may be better equipped to continue running the business, rather than having the deceased owner’s interest pass to their heirs, who may not have the same level of experience or expertise.
Buy-Sell Agreements- Important Considerations
To be effective, buy-sell agreements must be carefully drafted and tailored to the specific needs of the business and its owners. Some key considerations when drafting a buy-sell agreement include:
- Valuation: The agreement should specify how the value of the business will be determined in the event of an owner’s death or incapacity. This can be a complex issue, and it is important to work with a qualified valuation expert to ensure that the agreed-upon value is fair and accurate.
- Triggering events: The agreement should specify the events that will trigger the buyout provision, such as death, disability, retirement, or termination of employment. It is important to consider possible triggering events and to ensure that the agreement is clear and unambiguous.
- Purchase price: The agreement should specify the purchase price or formula that will be used to determine the purchase price.
- Funding: The agreement should specify how the buyout will be funded, such as through life insurance, a sinking fund, seller financing, or other means. It is important to ensure that the funding mechanism is adequate to cover the purchase price and that it is reliable
Buy-sell agreements can play an important role in estate planning for business owners. By providing a clear and orderly process for transferring ownership, these agreements can help to avoid disputes and ensure that the business continues to operate smoothly in the event of an owner’s death or incapacity. To be effective, buy-sell agreements must be carefully drafted and tailored to the specific needs of the business and its owners.
Charlotte-based attorney Christian Perrin is a North Carolina Bar Board Certified Specialist in Estate Planning and Probate Law. Based in Charlotte, Christian and his team serve clients throughout North Carolina and South Carolina.
Disclaimer: This information is intended to stimulate thought and discussion and to provide readers with useful ideas in the area of estate planning. However, this information does not constitute and should not be treated as legal advice or tax advice regarding the use of any particular estate planning technique, device or suggestion. Our law firm does not assume any responsibility for any individual’s reliance on the information presented. Each reader should verify independently all statements made before applying them to a particular fact pattern and should determine independently the legal and tax and other consequences of using any particular device, technique or suggestion.