Buy-sell agreements provide a clear, legally binding framework for the organized transfer of business ownership when triggering events occur.
With a buy-sell agreement, you can make a typically disruptive transfer as smooth as possible. This is especially true when the triggering event is the death of a partner or bankruptcy.
However, one major step in the process is choosing what type of buy-sell agreement is best for the business. There are three main types:
Cross-purchase agreements
In a cross-purchase agreement, you and other stakeholders agree to buy the shares of the departing owner. These purchases can be hefty, which is why most owners use life and/or disability insurance policies to fund the exchange.
When a stakeholder dies or becomes incapacitated, the other partners can use the proceeds from the departing stakeholder’s policies to buy their shares.
Because of its simplicity, this agreement can be advantageous if your business only has a few shareholders. On the other hand, it can easily become complex when there are too many owners, as each one will have to maintain separate insurance policies for every other owner.
Entity-purchase (redemption) agreements
An entity-purchase agreement, also known as a redemption agreement, allows the business entity itself to buy the shares of the departing owner. Usually, this agreement involves buying an insurance policy for each stakeholder that is equal to the value of their share.
The company itself will pay all the premiums and act as the beneficiary. If a stakeholder dies or leaves the company, the company can buy out their shares with the insurance payout.
Unlike cross-purchase agreements, redemption agreements offer a simpler plan for businesses with multiple owners. You only need one insurance policy, held by the company, instead of multiple policies between owners.
Hybrid agreements
Hybrid agreements combine elements of both cross-purchase and entity-purchase agreements. They allow the company and its owners to decide the best course of action when a triggering event happens, which offers a lot of flexibility.
Usually, the company has the first option to purchase the shares. If it chooses not to, the remaining owners have the option to purchase. If the owners also decline, the company must redeem the shares.
Essentially, this type of agreement can allow you and other stakeholders to make the best decision based on current financial circumstances.
Choosing the right buy-sell agreement can reduce disruptions for your business in case something happens. Consider speaking to a skilled business attorney who can help you understand each option so you can make the most informed decision.
