Structure and Tax Considerations of Buy-Sell Agreements

As with any contract, a buy-sell agreement must be structured properly to insure its effectiveness. There are several different ways to structure and fund the agreement. But, all agreements should contain and provide for the following.

• The agreement must contain commitment of the parties involved. As stated, the agreement is contractual and should state clearly the obligation of all interested parties in the contract.

• The agreement must state the purpose of the arrangement.

• The agreement must state or provide a formula dictating the purchase price of the business interest. The price must provide a value for the selling and buying price of the business.

• The agreement should specify how it should be funded.

• An agreement can be funded by life insurance, cash, instalment payments, and borrowing. If funded with life insurance, the agreement should state the type of life insurance and how the life insurance is to be paid for.

• The agreement should also contain transfer restrictions. This restricts the owners of a business from transferring interest in the business while all parties to the agreement are still living.

Three types buy-sell agreement

Cross-purchase agreement – (Stockholder Purchase) This is an agreement between two or more owners or shareholders stating that in the event ownership must be transferred the other owners of the company will purchase the business interest. This is the most common form of agreement. 

Entity purchase agreement – (Stock Redemption) This is an agreement that states the ownership in the business will be purchased by the entity. This agreement is more beneficial for larger businesses with several interested parties. 

Hybrid agreement – This agreement is a cross between a cross-purchase agreement and an entity purchase agreement. In this agreement, the withdrawing owner can first offer ownership to the entity. If the entity is unable to purchase or declines to purchase the ownership then the other owners or shareholders in the business may purchase the ownership themselves. The ownership can also be offered to the other owners or shareholders first and then offered to the entity.