Clint Wade owns 70 percent of the stock of Knock-Down Inc., a demolition and gra

Question

Clint Wade owns 70 percent of the stock of Knock-Down Inc., a demolition and gravel supply company. The remaining 30 percent of the stock is owned in equal shares by three of the key managers of the business.   The minority owners recently had their attorney draw up a “standard” buy-sell agreement to protect them in case one of them dies, retires, or wants out of the business. The agreement gives all the shareholders equal rights in the event of a triggering event. You represent Wade. How would you advise him?

Explanation / Answer

A buy–sell agreement, also known as a buyout agreement, is a legally binding agreement between co-owners of a business that governs the situation if a co-owner dies or is otherwise forced to leave the business, or chooses to leave the business.

It may be thought of as a sort of premarital agreement between business partners/shareholders or is sometimes called a "business will". An insured buy–sell agreement (triggered buyout is funded with life insurance on the participating owners' lives) is often recommended by business-succession specialists and financial planners to ensure that the buy–sell arrangement is well-funded and to guarantee that there will be money when the buy–sell event is triggered.

Clauses[edit]

A buy–sell agreement consists of several legally binding clauses in a business partnership or operating agreement or a separate, freestanding agreement, and controls the following business decisions:

Buy–sell agreement can be in the form of a cross-purchase plan or a repurchase (entity or stock-redemption) plan. For greater neutrality and effectiveness of the buy–sell arrangement, the service of a corporate trustee is recommended.

Wade should add these clause to the other minority owner and they should be agreed to one final ageement.

There are two basic types of Buy-Sell Agreements. There are advantages and disadvantages to each.

l) Entity Purchase Plan: The corporation agrees to buy (redeem) the interest of a deceased owner.

Advantages: Entity Purchase plans are easily understood. Only one life insurance policy on the life of each owner is needed to fund the agreement. Premiums are paid by the company. Proceeds are generally received income tax-free.

Disadvantages: There is no step-up in basis for a surviving owners' interest in a C Corporation and generally only a partial step-up in S Corporations and Partnerships. Problems with the Accumulated Earnings Tax and the corporate Alternative Minimum Tax are possible.

Cross Purchase Plan: Owners personally agree to buy the stock of a deceased owner. Advantages: There are no problems with corporate Accumulated Earnings Tax or corporate Alternative Minimum Tax. The cash values and proceeds are not available to corporate creditors. Owners get a new cost basis for the interest purchased, which could save taxes at a later sale. Disadvantages: If the plan is insured, it could require several insurance policies. For example, if there were 3 owners, 6 policies may need to be purchased. (The problem of multiple policies may be alleviated by using a "trusteed" type of cross purchase plan). There are many variations on the two basic types of Buy-Sell Agreements. An attorney should always be consulted to draft the actual Buy-Sell document.

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