Buy-Sell Agreements / Shareholders Agreements - Death Buy-Outs - PART I

We will be publishing a series on how small companies with more than one owner can structure their affairs if one of the owners should die, or some other contingency occur. Typically this is done in what is called a "Buy-Sell Agreement", which can also be called a Shareholders Agreement, for a closely held corporation. (you can set up a similar structure for LLC's and partnerships, the provisions will be contained in the Operating Agreement or Partnership Agreement, respectively). So while we will discuss the topic as it applies to corporations, just remember that it can apply to almost any business entity with more than one owner.

A Buy-Sell Agreement is an arrangement among shareholders of a corporation (or occasionally between a sole shareholder and one or more key employees) that provides for the purchase of the shares of one or more shareholders in specified circumstances. They must be reviewed periodically, because the business's financial situation may change significantly, particularly as it matures from its initial start up.

Why would you want a provision requiring purchase of shares in certain circumstances?

• Protects active shareholders by ensuring, when this is the deal, that all corporate shares are owned either by active shareholders or by persons who are willing to terminate when active involvement of a related person ends.

• Protects minority shareholders by preventing their being locked into an illiquid and non-income producing investment.

• In family corporations, it provides a formula for the valuation of the shares that may be effective for estate tax purposes, even though the purchaser is a family member. The Internal Revenue Code of 1986, section 2703 provides stringent requirements that the buy-sell agreement must meet, if it is not to be taken into account in valuing property for transfer taxation purposes. It may be used to provide senior securities, debt or preferred stock for the inactive family members and common stock for the active ones, even when the decedent was the sole shareholder, however, the stringent requirements of IRC §2701 must be met.

In later posts we will discover how you can use one of these provisions to your benefit and the benefit of your business.