Publications

Buy-Sell Agreements

You have invested a lot of sweat equity over the years to establish your business. It has become more than just a job, it has become your lifeblood. As a business owner, have you ever asked yourself the following questions:

What happens when your partner dies suddenly, or becomes permanently disabled?
what happens when you decide you have had enough and want out?
What happens to your share of the business when you want to retire?

Shareholders in closely held corporations often find it advantageous to enter into stock purchase agreements. A stock purchase agreement is a contract which provides that on the occurrence of certain events such as death, disability, retirement or the desire of the shareholders (you and your partner) to leave the business, there will be pre-determined mechanisms in place that will make the process run smoothly.

A stock purchase agreement can be useful to accomplish any in a number of objectives, including to:

prevent unwanted "partners" (i.e., heirs, etc.) From helping to run your business if your partner dies
pre-determine what your family will receive from the business in the event of your death or disability
establish the value of your stock for estate tax purposes, and
assure that the business will continue in control of the present shareholders and that no shareholder will sell his/her shares to an outsider without first offering the shares to current shareholders.

There are two types of stock purchase agreements — Stock Redemption Agreements and Cross Purchase Agreements. Both have distinct advantages and disadvantages, depending on a company's situation.

Stock Redemption Agreements

A stock redemption agreement is an agreement that provides that on the death, disability, retirement or departure from the business of one of the shareholders, the Corporation may be required or have the option of purchasing the stock of the deceased, disabled, or retiring shareholder. This type of agreement often is used when there are several shareholders. The disadvantage of this type of agreement is that on the death of a shareholder, the basis of the stock of the remaining shareholders is not increased. Further, if insurance proceeds are used to buy back the stock of a deceased shareholder, the Corporation may have to consider a portion of the proceeds as income for tax purposes.

Cross Purchase Agreement

A cross purchase agreement is the better alternative when the Corporation is owned by two shareholders although, it also may be used when there are more than two shareholders. Typically, each shareholder will buy insurance on the life of the other shareholder and use the proceeds to purchase the shares of the other shareholder upon death. After purchasing the deceased shareholders's stock basis will be increased, thereby reducing the capital gain in the event that the surviving shareholder subsequently sells the business. Further, insurance proceeds received by the surviving shareholder are not taxable.

Cross purchase agreements are difficult to implement when the Corporation has more than two shareholders. When insurance is used to fund the buy-out of the shares of a deceased shareholder, multiple policies have to be purchased on the lives of each shareholder to implement the agreement. Often an escrow agent will be used to hold the insurance policies in lieu of the individual shareholders.

The use of a stock purchase agreement for your business should aid in smooth transition of stock on the death, disability retirement or termination of employment of you or your partner. Taking care of these issues in advance of any of the foregoing events helps to avoid disruption of business and to promote the harmonious and successful transfer of your corporation's stock.