Buy-Sell Agreements are designed to ensure ownership succession upon certain triggering events such as the death, divorce, bankruptcy, disability, retirement of a partner, or the sale of interests by one or more business owners. Buy-Sell Agreements are effective at providing a set of rules and procedures for resolving shareholder or partner disputes, providing liquidity to the heirs of a deceased partner, protecting any S election made by the business, and protecting the business from a shareholders creditors.
- Cross-purchase arrangements allow or require the remaining shareholders to purchase the shares of any shareholder leaving the company by virtue of death, disability, or other triggering events. Cross-purchase agreements are typically funded with life insurance policies owned by each shareholder on the lives of the other shareholders. This is an unduly cumbersome arrangement when there are more than just a few shareholders.
- Upon the sale of shares under a cross-purchase agreement, the selling shareholder will have a capital gain. However, if the event triggering the buy-sell is the death of the shareholder, the heirs will have a stepped up basis in the decedent’s shares and may avoid recognizing a capital gain.
- Redemption agreements allow or require the company to buy the shares of a shareholder upon certain triggering events. Redemption agreements are typically funded with life insurance policies owned by the company on the lives of the shareholders, unless the company has sufficient cash reserves to dedicate a sinking fund to the redemption of the shareholders shares.
- Redemption agreements are simpler to administer than cross-purchase agreements because the company is the only policy owner.
- Under a redemption agreement, the selling shareholder typically will report the sale as a capital gain. Again, if the triggering event is the death of the shareholder, the heirs will enjoy a stepped up basis, and may not recognize any capital gain.