Types of Buy-Sell Agreements
There are three basic types of Buy-Sell Agreements, including: (1) cross-purchase; (2) stock redemption; and (3) hybrid. Depending on the business structure, number of owners, and owner involvement, one type may be more suited to your needs than another.
- Cross-purchase agreement:
With a cross-purchase agreement, shareholders agree to purchase the shares of another shareholder upon a triggering event, such as death, divorce, retirement, or disability. Typically, each shareholder owns insurance on the other shareholders in an amount that will fund the acquisition of stock in the event a shareholder dies. In a shareholder death scenario, depending on the terms of the agreement, shareholders may be required to or have the option to purchase the deceased shareholder’s stock at a predetermined price. Because cross-purchase agreements can become complicated in companies with numerous shareholders, these agreements are best suited for businesses with a few owners who hold relatively equal numbers of shares.
- Stock redemption agreement:
With a stock redemption agreement, corporation itself agrees to purchase the stock of a retiring, disables, divorcing, or deceased shareholder. The principal advantages of stock redemption agreements are cost and versatility. Insurance policies are often not required because the corporation acquires the stock and the cost of the repurchase is not born by the shareholders themselves. Stock purchase agreements are versatile because they can be created in situations where the shareholders are of varying ages and may not be able to acquire insurance on one another. They are also suited for larger business with multiple owners.
- Hybrid agreement:
Hybrid agreements are the most commonly used buy-sell agreement. They combine elements of both cross-purchase and stock redemption agreements. Hybrid agreements provide the corporation the option to purchase the withdrawing or deceased shareholder’s stock. If the corporation declines the purchase option, then the option passes to the remaining shareholders to the extent not exercised by the corporation.
Because triggering events such as death, divorce, and disability are unpredictable, having a Buy-Sell Agreement in place eliminates potential conflict between remaining shareholders and departing shareholders or their estates because shares will be transferred according to the terms of the Buy-Sell agreement. If you are interested in a Buy-Sell agreement for your business, contact J&J Legal today for a free consultation.