Janea Bellay

Buy-Sell Agreement for Business Owners

A buy-sell agreement may be thought of as a sort of “premarital agreement” between business partners/shareholders. It is sometimes called a ‘business will’.

It is a contract in which the various owners of a business agree that if one of them dies, or leaves the business for any other reason, the others will purchase his/her interest in the business. The parties to the contract may be partners, agreeing to purchase the interest of a partner who dies. They may be a father and son, where the son is to purchase the father’s business on death. Most commonly, however, we see buy-sell agreements between two or more shareholders of a private corporation, who agree to buy each other’s shares in the event of death.

An insured buy-sell agreement (agreement funded with life insurance on the participating owner’s lives) is often recommended by business succession specialists and financial planners to ensure the buy-sell arrangement is well-funded and also to guarantee there will be money when the buy-sell event is triggered.

In the sale of a business, a buy-sell clause (or Shotgun clause) in a shareholder agreement preserves continuity of ownership in the business and ensures that everyone is fairly treated, the buyer as well as the seller. It is a binding contract between business partners or shareholders about the future ownership of the business. A buy-sell agreement is made up of several legally binding clauses in a business partnership or operating agreement (or it can be a separate agreement that stands on its own) that can control the following business decisions:

• Who can buy a departing partner’s or shareholder’s share of the business. This may include outsiders or be limited to other partners/shareholders.
• What events will trigger a buyout. The most common events that trigger a buyout are: death, disability, retirement, or an owner leaving the company.
• What price will be paid for a partner’s or shareholder’s interest in the partnership.

Buy-sell agreement can be in the form of a cross-purchase plan or a repurchase (entity or stock-redemption) plan. For greater neutrality and effectiveness of the buy-sell arrangement, the service of a corporate trustee is recommended.

Essentially, a buy-sell agreement is:

“If a shareholder dies, the surviving shareholders agree to purchase the shares of the deceased shareholder, and the executor of the deceased shareholder agrees to sell the deceased shares for the purchase price set out in the agreement”.

The effect of the contractual obligation on the surviving shareholders is to create a need for capital on the death of the shareholder. For a financial planner, one of the first concerns in any buy-sell arrangement will be the funding of the agreement. Insurance is the most inexpensive way of financing.

Simply put, the agreement should deal with:

1. Who will buy the shares;

2. What the terms of the sale will be;

3. When the sale will take place;

4. Where the money to buy the shares will come from; and

5. How much the purchase price of the shares will be?

To ensure the agreement is viable, proper funding must be in place. Without proper funding, agreements can fall apart. The remaining owners benefit from a funded buy-sell agreement because the business is able to continue on with no unknown players to deal with. The ownership transition is handled smoothly, quickly and effectively.