Buy-Sell Agreement
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'. 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) and;
- What price will be paid for a partner's or shareholder's interest in the partnership and so on.
Buy-sell agreements 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.
The buy-sell agreement prevents an owner from selling his interests to an outsider without the consent of the other owners. The agreement usually takes one of three forms:
- Cross-Purchase Agreement -- In this form, a withdrawing owner agrees to sell his interest to the remaining owners. This is the simplest form of the buy-sell agreement. It is suitable especially for the small business with only a few owners. As the number of owners increase, this form can become unwieldy. In a larger business, an entity-purchase agreement may be more suitable.
- Entity-Purchase Agreement -- In this form of the buy-sell agreement, the withdrawing owner agrees to sell his interest to the entity, which then retires the ownership interest.
- Hybrid Agreement -- This form is a combination of the first two. Typically, the withdrawing owner must first offer his ownership interest to the entity. If the entity declines or is unable to make the purchase, then the shares must be offered to the other owners.
Ownership certificates must be endorsed with notice of the restriction on transfer created by the buy-sell agreement. In many cases, provincial statutes require that precise language be used in the ownership certificates. Thus, it is important to examine the particular province's statutes and incorporate the exact required language into all ownership certificates.
Buy-Sell Agreement Checklist
Buy-Sell Agreements: Has Your Company Addressed the Critical What If's?
The time to prevent disputes is before they occur. Our experience is that owners’ anxieties created in dealing with one another are inversely proportional to the effort they spend addressing business problems in the event that they should happen. Dealing with these contingencies before they manifest themselves is the secret to a harmonious business relationship with other owners. Legal fees as well as sleepless nights will be minimized if you agree to the "What If's" now.
Use the checklist below to determine areas where you may need assistance. Answer Yes or No to each question.
Applicability
- Should the agreement apply only to the current owners or should it be binding on all owners throughout the life of the business entity?
- Should the agreement provide that it supersedes all other agreements to redeem a business interest?
- Is the agreement being reviewed annually? (Changes of price or terms should require a unanimous vote of the owners.)
Type of Agreement
- Should the agreement be structured as a redemption agreement or as a cross-purchase agreement
- Should the agreement be structured:
- To require the seller to sell and the buyer to buy?
- To give the buyer an option to require the seller to sell?
- To give the seller an option to require the buyer to buy?
- To give a right of first refusal to the buyer?
- As a combination of any of the above?
- Should the death of an owner cause an automatic buyout of the owner’s interest or should his/her family be allowed to remain as an owner?
Buyout Price and Time for Payout
- Should the buyout price from the estate or heirs of a deceased owner be addressed? If yes, when should it be paid?________ What interest rate should the obligation bear?_________
- Should the buyout price to a disabled owner be addressed? If yes, when would it be paid?_______
- Should the buyout price to an owner who resigns or is dismissed be addressed? If yes, when should it be paid?________
- Should there be a difference in price if there is an amiable parting of ways? If yes, when should it be paid?_______
- Should the buyout price to an owner who goes bankrupt be addressed? If yes, when should it be paid? _________
- Should the price reflect the fact that you are selling to a long time business associate rather than an outsider?
Funding
- Should the agreement provide that the buyout be funded by life insurance or some other investment vehicle?
- If funded with life insurance: Should the type of life insurance used be addressed (i.e. term life, ordinary life, last to die, paid-up life, universal life or an endowment policy?)
- Should a life insurance trust be used?
- Should all of the policy proceeds be required to be used to redeem the interest?
- Can part of the proceeds be used to help the entity recover from the loss of the owner?
- Should whole life insurance policies with cash values be transferred to the owner at termination or retirement?
Security
- Should the agreement be guaranteed or secured?
- If so, should the security be in the form of:
- A pledge of business assets?
- A personal guarantee by the other owners?
- An agreement obligating the entity to refrain from increasing salaries, paying dividends or making loans until all outstanding liabilities to the beneficiaries are paid?
Loans
- Should the disposition of owners' loans, whether receivables or payables, in the event of termination because of death or disability be addressed?
- Should the disposition of owners' loans in the event of termination other than because of death or disability be addressed?
Covenant Not to Compete
- Should there be a covenant not to compete? If so, should there be geographic and time limitations?
Other
- Should there be a period of disability before the other owners of the business have the right to buy out a disabled owner?
- Should an owner have the right to transfer or assign to a trust, for estate-tax planning purposes, their rights and interests in the business?
- Should the spouses of the owners sign the buy/sell agreement?
- Do other family members presently own any stock?
Buy-Sell Agreement
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'. 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) and;
- What price will be paid for a partner's or shareholder's interest in the partnership and so on.
Buy-sell agreements 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.
The buy-sell agreement prevents an owner from selling his interests to an outsider without the consent of the other owners. The agreement usually takes one of three forms:
- Cross-Purchase Agreement -- In this form, a withdrawing owner agrees to sell his interest to the remaining owners. This is the simplest form of the buy-sell agreement. It is suitable especially for the small business with only a few owners. As the number of owners increase, this form can become unwieldy. In a larger business, an entity-purchase agreement may be more suitable.
- Entity-Purchase Agreement -- In this form of the buy-sell agreement, the withdrawing owner agrees to sell his interest to the entity, which then retires the ownership interest.
- Hybrid Agreement -- This form is a combination of the first two. Typically, the withdrawing owner must first offer his ownership interest to the entity. If the entity declines or is unable to make the purchase, then the shares must be offered to the other owners.
Ownership certificates must be endorsed with notice of the restriction on transfer created by the buy-sell agreement. In many cases, provincial statutes require that precise language be used in the ownership certificates. Thus, it is important to examine the particular province's statutes and incorporate the exact required language into all ownership certificates.
Buy-Sell Agreement Checklist
Buy-Sell Agreements: Has Your Company Addressed the Critical What If's?
The time to prevent disputes is before they occur. Our experience is that owners’ anxieties created in dealing with one another are inversely proportional to the effort they spend addressing business problems in the event that they should happen. Dealing with these contingencies before they manifest themselves is the secret to a harmonious business relationship with other owners. Legal fees as well as sleepless nights will be minimized if you agree to the "What If's" now.
Use the checklist below to determine areas where you may need assistance. Answer Yes or No to each question.
Applicability
- Should the agreement apply only to the current owners or should it be binding on all owners throughout the life of the business entity?
- Should the agreement provide that it supersedes all other agreements to redeem a business interest?
- Is the agreement being reviewed annually? (Changes of price or terms should require a unanimous vote of the owners.)
Type of Agreement
- Should the agreement be structured as a redemption agreement or as a cross-purchase agreement
- Should the agreement be structured:
- To require the seller to sell and the buyer to buy?
- To give the buyer an option to require the seller to sell?
- To give the seller an option to require the buyer to buy?
- To give a right of first refusal to the buyer?
- As a combination of any of the above?
- Should the death of an owner cause an automatic buyout of the owner’s interest or should his/her family be allowed to remain as an owner?
Buyout Price and Time for Payout
- Should the buyout price from the estate or heirs of a deceased owner be addressed? If yes, when should it be paid?________ What interest rate should the obligation bear?_________
- Should the buyout price to a disabled owner be addressed? If yes, when would it be paid?_______
- Should the buyout price to an owner who resigns or is dismissed be addressed? If yes, when should it be paid?________
- Should there be a difference in price if there is an amiable parting of ways? If yes, when should it be paid?_______
- Should the buyout price to an owner who goes bankrupt be addressed? If yes, when should it be paid? _________
- Should the price reflect the fact that you are selling to a long time business associate rather than an outsider?
Funding
- Should the agreement provide that the buyout be funded by life insurance or some other investment vehicle?
- If funded with life insurance: Should the type of life insurance used be addressed (i.e. term life, ordinary life, last to die, paid-up life, universal life or an endowment policy?)
- Should a life insurance trust be used?
- Should all of the policy proceeds be required to be used to redeem the interest?
- Can part of the proceeds be used to help the entity recover from the loss of the owner?
- Should whole life insurance policies with cash values be transferred to the owner at termination or retirement?
Security
- Should the agreement be guaranteed or secured?
- If so, should the security be in the form of:
- A pledge of business assets?
- A personal guarantee by the other owners?
- An agreement obligating the entity to refrain from increasing salaries, paying dividends or making loans until all outstanding liabilities to the beneficiaries are paid?
Loans
- Should the disposition of owners' loans, whether receivables or payables, in the event of termination because of death or disability be addressed?
- Should the disposition of owners' loans in the event of termination other than because of death or disability be addressed?
Covenant Not to Compete
- Should there be a covenant not to compete? If so, should there be geographic and time limitations?
Other
- Should there be a period of disability before the other owners of the business have the right to buy out a disabled owner?
- Should an owner have the right to transfer or assign to a trust, for estate-tax planning purposes, their rights and interests in the business?
- Should the spouses of the owners sign the buy/sell agreement?
- Do other family members presently own any stock?