Buy/Sell Agreements and Family Businesses

Buy/Sell Agreements and Family Businesses

Buy/Sell Agreements between owners of a business determine how, when and which of an owner’s interest may be bought out by the other owner(s) of the enterprise upon events such as death, disability, retirement, and management deadlock.

In the case of partnership or a limited liability company, buy/sell provisions are typically embedded, respectively, into the partnership agreement or the company’s operating agreement.  In the case of a corporation, those provisions are generally the subject of a separate document known as a “shareholders agreement.”

There are many considerations in drafting such an agreement.  For example, the triggering event that invokes the buy/sell obligation must be specified.  Death is straight forward, but consider “disability”.  Who determines when a shareholder is “disabled,” a company physician, the shareholders physician, or both?  Another example is retirement, the triggering event in a retirement is a one-sided and voluntary decision to retire, but how much notice must the retiring owner give to the company?

Looming large on the list of considerations is valuation of the business interest to be bought out.  This is frequently the object of contention; buy/sell provisions that spell out a method or a formula for valuation may eliminate or at least clarify the issue.  A valuation method may employ one or more appraisers, or the agreement may specify a simple arrangement such as use of the “book value” of the company as determined by the company’s regularly retained accountant.

Along with valuation come related issues such as terms of payment (over time, in a lump sum, or some combination of the two), whether the company keeps insurance in place to fund the buy-out, and the basic consideration of whether the enterprise is buying the owner’s shares (a redemption) or whether one or more of the other owners are buying the withdrawing owner’s shares (a cross-purchase).

Many of these decisions have income tax consequences and sometimes estate tax consequences.  At least some thought should be given to the tax issues at the drafting stage, although buy/sell arrangements that provide the owners with clearly set forth options may delay some of the heavy tax analysis to a later date.

A detailed discussion of all the features of a buy-sell agreement is beyond the scope of this short article, but the subjects dealt with in such an agreement can be vital to business succession planning. 

— Rod Fluck

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