Business owners, including business brokers, should take a moment to answer this important question: what happens to the interest in your company when you decide to sell your shares, you become incapacitated, or you are deceased?

If your answer to the question is “I don’t know,” you aren’t alone.

Many businesses fail to answer these important questions prior to entering into a new business venture with another individual. If a business has already been formed, it is likely too late for a business to incorporate these important what if’s into their by-laws. Furthermore, an amendment to the by-laws is not an ideal method to reflect the intent of the shareholders. Instead, the shareholders should enter into what is referred to as a buy/sell agreement.

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/chooses to leave the business. It can be signed at any time during the “life” of a business. A buy/sell agreement often contains the consent of a spouse if the shareholder is married at the time of the agreement. This may be something that is added to the agreement if the shareholder becomes married in the future.

Buy/sell agreements are often broken down into a few different forms. In a cross-purchase agreement, the remaining owners purchase the shares of the business that are for sale. However, in a redemption agreement, the business buys the outstanding shares from the decedent of the shareholder that has inherited the shares. Sometimes, the parties will agree to a mixture of both the cross-purchase method and redemption method; this is sometimes referred to as a “hybrid” form of a buy/sell agreement.

Buy/sell agreements are put into place in order to help shareholders navigate the murky waters of protecting both their personal interests and the interests of the business. For example, a buy/sell agreement can restrict shareholders from selling their shares to an outside party without prior approval by the remaining shareholders. These clauses are also popular in the event of dealing with the death of a shareholder. It would be problematic for a spouse to inherit shares to a business then threaten to sell the shares to an outside party that is not wanted by the original remaining shareholders. If the company has already executed a buy/sell agreement, the company would be protected by the previously executed buy/sell agreement and either the company or the shareholders would acquire the newly acquired shares instead of the outside party.

A buy/sell agreement is a document that should not be overlooked when considering the structure of your business. If you hold interest in a company with another person or business entity, you should consider a buy/sell agreement. Your opinion of your business partner today may not reflect your opinion of your business partner in the next fifteen years. If you have any questions about buy/sell agreements or any other aspects of business structuring, please contact us by email at rbasi@taxplanning.com or michael@taxplanning.com. Feel free to also call us at (618)-997-3436 and let us help protect your interests.

By: Michael S. Hampleman & Roman A. Basi

Michael S. Hampleman is an Associate Attorney at the Center for Financial, Legal & Tax Planning, Inc.

Roman A. Basi is an Expert on Closely Held Enterprises. He is an attorney/CPA and the president of the Center for Financial, Legal & Tax Planning, Inc.