Financial Planning

Buy and Sell Agreements

A buy sell arrangement is a legal agreement which covers the purchase of all of the corporate shares of a deceased, retired, disabled, or disgruntled stockholder. The legal wording can be included in the articles of incorporation or bylaws, or in a separate legal agreement. Every closely held corporation should have a buy/sell agreement in place, regardless of whether there is one owner or many. The reasons for this include:

Non-Marketability of stock—there is no public forum, such as the NYSE, for the selling of stock in a closely-held corporation. Minority stockholders have a particularly difficult problem, since there is a lack of corporate control. The legal agreement assures each stockholder that there will be an orderly disposition of shares with a fair price paid to the seller. In the case of a sole shareholder corporation, it assures the heirs who are unable or uninterested in running the business that they can sell at a price above liquidation value.
Estate tax reasons—Buy/Sell arrangements usually fixes the value of the corporate stock for the calculation of federal and state death taxes. In the absence of an agreement, there is a good chance that the government will challenge the value used in these calculations. Tax laws affecting the heirs of family businesses make it very likely that the shares will be included in the estate of the giftor even though they were gifted many years earlier. Proper buy/ sell planning is one of the effective 'estate freezing techniques' remaining after the Tax Reform Act of 1986.
Unplanned partners—You may enjoy your current relationship with your co-owner, but how would you like their spouse as a replacement? Buy/Sell agreements assure that this will not happen.
Undesirable financial risk for your heirs—It may be desirable to have your heirs inherit cash rather than shares in a risky enterprise.

Contingencies Covered
The arrangements usually cover three contingencies:

Death of a Stockholder—Life insurance is most frequently used to fund the buyout.
Disability of a Shareholder/ Employee—It is not critical to provide for the buyout of a disabled shareholder who is not active in the business. But if the shareholder was active and can no longer perform the duties which made them key to the success of the enterprise, it may not be fair or desirable for them to remain as owners if they are going to be unable to work for a long period of time. Lump sum disability buyout insurance is available to fund such buyouts and is surprisingly inexpensive.
Lifetime Buyout—A buyout may be desirable due to the retirement of a shareholder, a disagreement between owners, or an amiable departing. The formula to use for the value of the stock in such an event should be laid out ahead of time. Funding options should be planned.

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