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What Is a Buy-Sell Agreement?

A buy-sell agreement is a legal contract that is common in closely held businesses. It is an agreement you can enter into now that provides for the future sale of your business interest. A buy-sell agreement is also referred to as a business continuation agreement, a stock purchase agreement, or a buyout agreement. When carefully drafted, your buy-sell agreement may be used to set the taxable value of your business interest.

Why You Might Want to Have a Buy-Sell Agreement with Your Nonfamily Buyer

Legal Contract Provides Measure of Security

Perhaps the most compelling reason to draft a buy-sell agreement with the intended nonfamily buyer of your business is the added security it provides you and your family. A buy-sell agreement is a legal contract, and as such it provides a measure of security for both parties to the sale. In other words, you know the buyer is bound by contract to buy your interest, and the buyer knows that you are not allowed to sell to another party. If either party attempts to back out of the deal, the other party can seek to have the contract enforced by the court system.

Caution: Once you are bound under a buy-sell agreement and the agreement remains in effect, you can't sell your interest in the business to any party except the buyer named in the agreement.

Establishes Buyer, Conditions of Sale for Your Interest

A buy-sell agreement identifies a buyer or potential buyer of your business interest and the conditions under which a sale will occur. The buyer could be an individual or an entity, and there can be more than one buyer. You can choose the events that will trigger the sale of your interest under the agreement. Typical trigger events include death, long-term disability, retirement, and divorce.

May Improve Creditworthiness of Business While You Still Own It

A buy-sell agreement may increase the probability of the business continuing successfully after the death or withdrawal of an owner. The continued existence of the business means the continued ability to meet outstanding loan payments. Creditors may view the business as more stable and the owners as responsible business people, and therefore they may be more likely to extend credit to the business.

Caution: Restrictions within the buy-sell agreement could prohibit you from pledging your own interest in the business as collateral for outside credit or could require the consent of the other owners (if any). Without the ability to pledge your business interest, it may actually be more difficult to get a loan.

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Can Avoid Fire Sale of Business

When you have a buy-sell agreement in place with the unrelated buyer of your business, your family is relieved of any potential worries about what to do with your business should you become sick, disabled, or die. Your plans for the business will have already been established and the pricing and financing terms agreed to in writing. Your family won't have to search for a buyer or be at a negotiating disadvantage when they find one. The buy-sell agreement can be used to ensure that a fair price is received for your business interest, thus avoiding a "fire sale."

Can Be Used With Every Type and Size of Business Entity

Buy-sell agreements can be set up for companies that have either one or many owners. The size of your company will affect your choices in setting up your specific form of buy-sell agreement, and though it may cause one form to be more appropriate than another, it would not generally prohibit you from having a buy-sell agreement. Just as there are different business ownership arrangements, there are different forms of buy-sell agreements. One of the distinguishing features between the different buy-sell agreement forms is the buyer to the transaction. The buyer could be any or all of the current co-owners, an outside third party, or the business entity itself. There can be more than one buyer.

The following table illustrates the various types of buy-sell agreements that are commonly found, the typical buyer, and what forms of business organization and size each form is best suited for. Within the basic forms of agreement, you can custom-fit your buy-sell agreement to your particular business through the use of various clauses, options, and requirements.

 

Overview of Buy-Sell Agreement Forms

Agreement Form

Buyer

Works Well With

Unsuitable For

Wait and see

Business entity, co-owner, or both

Business with two or more owners

Sole proprietor and single shareholder corporation

Trusteed cross purchase

Co-owner transaction overseen by trustee

(1) Business with two or more owners (2) Simplifies plan when large number of owners

Sole proprietor and single shareholder corporation

Entity purchase stock redemption

Business entity

Business with two or more owners

Sole proprietor and single shareholder corporation

Section 302 stock redemption

Business entity

Business with two or more owners

Sole proprietor and single shareholder corporation

Section 303 stock redemption

Business entity

Business with two or more owners, especially family business

Sole proprietor and single shareholder corporation

Reverse Section 303 stock redemption

Business entity

Business with two or more owners, especially family business

Sole proprietor and single shareholder corporation

Cross purchase (crisscross) agreement

Co-owner

Business with two or more owners

Sole proprietor and single shareholder corporation; Large number of owners (may become complicated with four or more)

Option plan

(1)Business entity, Co-owner, or any eligible third party (2) Sale not guaranteed

Business with any number of owners including sole proprietorship and single shareholder corporation

Any scenario where guaranteed sale is needed

One-way buy-sell

Business entity, co-owner, or any eligible third party

Business with any number of owners including sole proprietorship and single shareholder corporation

Sole proprietor with no willing buyer

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

 

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