Why Use A Buy-Sell Agreement?
A Buy-Sell Agreement, sometimes also called a shareholder’s
agreement is a legally binding agreement among the shareholders
(of a corporation) or interest holders (with a limited liability
company) or partners (with a general partnership). The Buy-Sell
Agreement places certain restrictions on the transfer of stock,
membership interests, or partnership interests and may also
require certain actions to be taken on defined triggering events
like the death or retirement of a shareholder or partner.
Although most frequently used by s-corporation shareholders, a
Buy-Sell Agreement is also well suited to fit the needs of
sole-proprietors, partnerships, and single-member limited
liability companies. A Buy-Sell Agreement is a critical tool
in stabilizing the value of a closely held business and for
transferring it under specified circumstances to the desired
The nature of a closely held business (a business in which the
majority shareholders (and their families) receive most of their
income from the business in the form of salaries and other
benefits) can cause significant problems when ownership changes
because of death, disability, retirement, divorce, bankruptcy or
sale to third-party. A properly drafted Buy-Sell Agreement
can address what happens under these “triggering” circumstances as
well as provide for methods of funding the buy-out and the tax
issues associated with such buy-outs.
It can also cover the problems that arise out of special or
unique issues such as when the company has elected S corporation
tax treatment. In fact, only a Buy-Sell Agreement can
guarantee the surviving or remaining shareholders that management
and corporate control will remain with the individual or group
that they have all agreed on.
Buy-Sell Agreements can take different forms and are sometimes
simply provisions in other agreements (e.g., they are often found
in a limited liability company operating agreement). Typically
though they are stand-alone agreements that can be either
cross-purchase agreements, where the surviving or remaining
shareholders purchase the shares or the departing shareholder
stock or interest) redemption agreements where the corporation (or
limited liability company) is the purchaser.
In the typical cross-purchase agreement, on the death of a
shareholder, the other shareholders would be required to purchase
the deceased shareholder’s stock (or membership interests) and the
estate would be required to sell it at an agreed price or
according to an agreed formula.
The purchase can be funded with cash, paid for on an installment basis through a promissory note or through life insurance. With a properly drafted, properly funded Buy-Sell Agreement, the deceased shareholder’s estate gets cash and/or promissory notes and the buyers get stock (or membership interests) in return. Thus, a properly drafted and funded Buy-Sell Agreement can prevent the fire sale of the business on the death of a shareholder to pay costs associated with the death such as estate taxes.
The best time to enter into these agreements is at the outset
of the business relationship, but they can be entered into at any
time. Hopefully, the above is enough information to get you
motivated to begin the process of developing a solid Buy-Sell
Agreement. Keep in mind, the ultimate structure and funding
of the Buy-Sell Agreement depends on many factors such as the
number of owners or partners, the immediate and long-term needs of
the business and the shareholders as well as the tax consequences.
With all legally binding agreements, the aid of legal, tax, or
insurance professionals is strongly suggested.
Author James Vignione, administrator of Orion Systems
specializes in free business forms,
legal forms, and business information to help people with their
business and personal affairs.
For more information, visit