The death, disability and / or retirement of a shareholder in a closely held corporation can give rise to a number of problems for the surviving shareholders and in the case of death, for the estate of the deceased.

The primary objective of a well designed buy / sell agreement would be to supply a fair cash settlement to the estate of the deceased, while at the same time allowing the remaining shareholders to continue with their control of the business.

There are two basic methods for structuring the buy - out of a shareholder on death:

1) Shares of an operating company or by a holding company owned by the deceased, could purchased by the surviving shareholders or by their holding company.
2) The operating company may purchase for cancellation the shares owned by the deceased or the deceased's holding company.

• To allow for the smooth transition of the business which satisfies the needs of both employees and creditors, along with maintaining the value of the company. Without a buy / sell agreement, the uncertainty as to the transition of control would cause employees to leave and creditors to get nervous.
• The provisions of the agreement would minimize confrontation between the estate and the remaining shareholders. It is highly likely that the interests of the estate and tat of the remaining shareholder will not be the same.
• The shares may form a large part of the deceased's estate and the family would most likely need to replace the salary. With no buy / sell agreement in place it is possible that no purchaser would be found for the shares, especially if the estate inherits a minority interest.
• The terms of the buy / sell agreement are normally agreed to when all parties are in good health. The estate is therefore protected by such an agreement because it is more likely that a fair price would have been set for the shares, especially as the parties would not have known who would be the first to die
• With no agreement in place, the estate may find itself in the position of being taxed as a result of the deemed disposition of the shares without receiving the proceeds of the sale, and with little or no expectation of receiving dividends.

There are many variations as to how buy / sell agreements can be structured; however, they are normally based on one of the following formats:

THE OPTION AGREEMENT:
This is probably the simplest form of buy / sell which allows the remaining shareholders to purchase the deceased's shares in a stated proportion within a certain period of time (usually 60 days), at a price determined under the agreement. If the shares are not purchased under the option, the estate would be free to sell elsewhere.

The overall difficulty with the option route is that it does not guarantee a market for the shares or the business interest held by any party. If the option is not exercised. the estate may be stuck with shares that it cannot sell, and the remaining shareholders with a beneficiary that it does not necessarily want as a business partner.

THE PUT - CALL AGREEMENT:

This arrangement is an alternative to the option agreement and is sometimes called the "Shotgun" agreement. Under this agreement the estate would b required to name a sale price. The remaining shareholders could then purchase these shares at that price, in an agreed ratio, probably proportionate to their present holding in the corporation.

If the remaining shareholders do not purchase the outstanding shares, the put - call agreement will allow them to tender their shares to the estate at the same price, and on the same terms. The estate will then be bound contractually to purchase as many shares as are tendered.

This technique is particularly attractive in a living buy - out situation to provide for the resolution of dissension among shareholders.

However, this arrangement does have the potential of inflicting financial demands on the family or estate of the deceased at a time when they are least capable of arranging the required financing.

THE BINDING BUY / SELL AGREEMENT:

The binding agreement is structured in such a way as to require the other shareholders to purchase their deceased shareholder's interest at a fair price. This type of agreement not only ensures a market for the deceased's shares, but for the remaining shareholders. it also controls entry of other parties into the business without their consent.

While this arrangement may provide the best solution, it does require funding that will most likely have to be borne by each of the shareholders or by the corporation.

This clause in the buy / sell agreement is of great importance as the price, or method of determining the price, will impact both the funding mechanism used, and the amount of taxation which will be levied on a shareholder's death.

Although many methods of determining the price exist, it is important to recognize the impact of business expansion and / or inflation on these calculations.

Arguably one of the best methods used combines agreement between the parties and independent arbitration. A fixed price is agreed upon, with the parties also agreeing to make periodic adjustments; the arbitrator is consulted when there is disagreement. These periodic adjustments could present some practical problems and the solution may lie in requiring an annual revision of the buy / sell as an item of business at the corporation's annual shareholder's meeting.

When reviewing the pros and cons of the different buy / sell structures and funding methods, it becomes very apparent that in most situations the best solution would be a binding agreement that is adequately funded by life insurance.

This combination ensures a fair cash settlement to the estate of the deceased while allowing the remaining shareholders to continue with their control of the business.

There are many things to consider when deciding on the ownership of policies used to fund these agreements. This decision will depend on the structure of the business, premium costs, as well as the many tax considerations that need to be reviewed.

Insurance funding should also be considered even when not all of the shareholders are insurable. When this situation rises one of the alternate methods of funding may be adopted for the uninsurable shareholder.

Premiums paid under these policies are generally not deductible as an expense for tax purposes. However if certain conditions are met, the "Net Cost of Pure Insurance" can be deducted when the policy has been used as collateral to guarantee a business loan.

I would be pleased to show you a broad range of well designed, quality products that can be used to fund buy / sell agreements.

If you have questions or concerns regarding this topic, please do not hesitate to call me or to use the Book An Appointment Form.