Virtually all small closely held businesses should have an up-to-date Buy-Sell Agreement. A Buy-Sell Agreement should accomplish a number of important objectives for closely held company, including: (1) providing mechanism for the orderly transfer of the business; (2) establishing a valuation mechanism which avoids disputes between owners as well as possible disputes with the Internal Revenue Service; (3) reducing possible disputes between owners, an owner’s heirs, and possible unwanted business partners to whom an ownership interest in the company may otherwise be transferred; and (4) providing financial security to a deceased or disabled owner’s family.
It is important that company’s Buy-Sell Agreement be reviewed periodically to make certain that it is properly customized to the needs of the specific company and its owners, as well as to make certain the agreement meets the requirements of current tax laws. Two of the most important areas of periodic review are the valuation provisions in the Buy-Sell Agreement and the funding of the buy-sell arrangement set forth in the Buy-Sell Agreement.. Valuation formulas based upon earnings can become obsolete and should be updated periodically based upon changes in a company’s accounting and compensation practices. Funding of the buy-sell arrangement should also be periodically updated to avoid a situation where there is a gap between the value of the company and the available funding.
Another aspect of the Buy-Sell Agreement that should be reviewed periodically is the agreement’s structure. Typically, Buy-Sell Agreements are structured as either a redemption agreement, a cross-purchase agreement, or hybrid agreement. It is important to review the structure of a Buy-Sell Agreement to determine if a different structure would be more beneficial in light of the corporate alternative minimum tax on life insurance proceeds. In addition there are also basis considerations to take into account when reviewing the structure of a Buy-Sell Agreement, in order to avoid serious income tax consequences.
Lastly, a periodic review of a Buy-Sell Agreement should include a careful review of the triggering events which either allow or require a transfer of ownership. While most Buy-Sell Agreements adequately deal with the death of an owner, it is equally as important to make sure that the Buy-Sell Agreement adequately covers other triggering events such as disability, voluntary termination of employment, involuntary termination of employment, bankruptcy of an owner, and the divorce of an owner.
When reviewing a Buy-Sell Agreement, it is important to take into account the unique needs of each company, the existing relationships between owners, as well as the individual functions of each owner. It is also important to do an analysis of the underlying economics of the company when considering an update of Buy-Sell Agreement.