What is a Buy-Sell Agreement, and how does it work in the event of death or disability of a company owner?
A buy-sell agreement deals with the death or disability or termination of employment of a key owner or owners of a closely held corporation to provide for the sale of that person’s interest.
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Your business may be the primary asset that provides income and security for you and your family.
The owners and shareholders of many closely held corporations understandably find it hard to plan for the risk of the death, disability, or voluntary or involuntary termination of employment of the company owner(s). Buy-sell agreements include provisions governing those situations and legally enforceable restrictions on the transfer of stock. They provide for the “redemption” of stock by the corporation or purchase by one or more of the remaining shareholders. For the selling shareholder, the agreement may assure a buyer for the seller’s stock at a fair price as determined by an agreed-upon formula or process.
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What can a more sophisticated buy-sell agreement provide that simple right of first refusal provisions in the Articles of Organization cannot?
While buy-sell agreements serve key corporate and individual shareholder’s purposes, the frequently encountered problem is that most closely-held businesses have only the simplest of agreements. They often fail to solve the financial and governance problems that may undermine an orderly transition in the ownership of the business. Many companies are incorporated with only boiler-plate first refusal language in their Articles of Organization. A sophisticated buy-sell agreement will address key tax issues and also determine who is the selling party, the buying entity, and the source of the funds – usually either a promissory note secured by certain provisions for payment from future income or better yet, a corporate split-dollar insurance policy or some combination of the two. Attorney Morse works with the tax and other advisers to provide the necessary advice.
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What are the Three Common Types of Buy-Sell Agreements?
The question arises as to who is the appropriate buyer of the selling shareholder’s shares. There are three common types of Buy-Sell Agreements: (1) Corporate Redemption Agreement; (2) The Cross-Purchase Agreement; and (3) the Hybrid or “Wait-and-See” Agreement. In the Corporate Redemption Agreement, corporate funds are used to purchase the shares, either directly through current or accumulated earnings, or through the payment of insurance premiums. If insurance is expected to be the funding source, this corporate approach can result in a simpler insurance program than a cross-purchase approach. The Cross-Purchase Agreement provides for one or more of the remaining shareholders to purchase the stock of the departing shareholder. Each shareholder must own insurance on the life of every other shareholder. The Hybrid or “Wait-and-See” Agreement may provide needed flexibility. The corporation might have the first option to redeem shares, and if it chooses not to exercise that option, remaining shareholders would then have the option to purchase the shares. If the shareholders do not do so, then the corporation could be required to purchase the shares.
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What are Other Provisions Commonly Found in Cross-Purchase and Other Agreements to Protect the Company against Unfair Competition Of A Departing Owner/Employee?
Anticipating the possible departure of one of the key owners or employees, there arise issues of non-competition, non-solicitation of customers and employees, and confidentiality or nondisclosure of key confidential data or trade secret. Language that deals with these issues should be put in the Buy-Sell Agreement and in employment or separate agreements for key employees and sometimes almost all employees with access to important data. It can spell out the parties’ expectations of their duties to the enterprise. It may contain employment rights and identify expectations as to who the officers and directors will be. These non-competition, non-solicitation and nondisclosure agreements can be rendered ineffective to invalid under some circumstances so advice here is very important.