07 Aug What are Buy/Sell Agreements and how do they work?
Buy / Sell Agreements are contracts between the owners of a business used in the context of business succession to allow for the sale of a co-owners interest on the occurrence of a specified triggering event, such as their death, permanent total disablement (PTD), bankruptcy or retirement (Trigger Event). There are many different ways these agreements can work. For example, the agreement can allow the remaining owners (or the business itself) to purchase the outgoing co-owners interest (i.e. a call option). Alternatively (or sometimes concurrently), the agreement could allow the outgoing co-owner (or their estate) to sell their business interest to the remaining owners (i.e. a put option). Often the agreement is structured with both a put and a call option.
Buy / Sell Agreements are commonly used in conjunction with an appropriate policy of insurance to ensure that the remaining owners have the capacity to fund the acquisition of the outgoing or deceased owners interest. Upon the occurrence of a Trigger Event, the remaining owners will apply the “pay-out” from the insurance policy to pay the outgoing principals business.
There are a broad range of ways that a Buy / Sell Agreement can be structured (including in relation to who has the right to buy / sell a business interest on the occurrence of a Trigger Event and in whose name insurance will be taken out), each having different tax consequences. A poorly drafted Buy / Sell Agreement can have detrimental tax consequences for the continuing business owners and the existing owner (or their estate).
While every business relationship is different, in our experience, it is usually easier for co-owners to reach a more reasonable position regarding the treatment of their respective business interests if appropriate action is taken before a Trigger Event occurs or becomes impending. It may become far more difficult to reach a fair agreement (or any agreement at all) in circumstances where an owner has decided (or is forced) to retire or otherwise exit the business because the continuing owners and exiting owner will have completely different objectives. These issues can be largely avoided by investing time in implementing a business succession plan (including a Buy / Sell Agreement).
ARTICLE CONTRIBUTED BY ERIN BROWN
Erin is a Senior Associate at McCabes. She is in the corporate and commercial group and has over ten years experience in capital raising, mergers and acquisitions and private equity transactions. Erin regularly acts for small and mid-market clients in the mining services, manufacturing and engineering and retail sectors.