Factors to consider when selecting the type of Buy and Sell Agreement for your business.(I)
Before you can design a buy and sell (BS) you need to consider the following:
- Number of owners: the greater the number, the more likely the BS will be a stock-redemption.
- Nature and size of the entity: As a rule, a larger company will call for a redemption BS, or hybrid do to the fact that ownership interests will probably be worth more.
- Value of the entity: The higher the value, greater chance of a redemption BS.
- Relative ownership interests: Because of larger interest in ownership, greater likely hood a redemption or hybrid because of the cost to purchase.
- Ages of owners: If there is a wide disparity in age between owners, greater chance of using a stock redemption or hybrid BS agreement?
- Financial conditions of the owners: The more questionable an owner’s finances are the more likely a redemption/hybrid.
- Enforcement of buy-sell agreement: If there is a question as to the likelihood of partners reneging on the BS, or unable to fulfill the purchase obligation, the more likely a redemption/hybrid.
- Desires for new cost basis for the purchasing owner: Chances are a cross purchase arrangement would be used if surviving purchasing partner wanted a higher cost basis.
- Health and insurability of the owners: When there are younger or unhealthy partners, the disparity in premiums will tend to adversely affect the other owners, consequently, redemption will be used.
- Commitment of owners to business: Cross purchase or hybrid can be used so the more committed partner can purchase the non-interested partner directly.
- Availability of assets inside of the entity for redeeming the interest: Since some businesses have minimum-asset performance-bonding, a cross purchase BS would be used. General Contractors would be an example.
- State law with respect to entity redemptions: If lightly capitalized, use cross purchase.
- Existence of restrictions under loan agreements on the use of the entity’s assets to redeem equity interests: Loan agreements may have restrictions on the use of assets as they are the collateral for the loans, usually would use cross purchase.
- Family relationships within the business: Maintaining equal ownership between family members can be a challenge, normally, a cross purchase agreement works the best, unless the business is capitalized to have different classes of stock.
- Professional licensing or other qualification requirements: Licensing and professional designations with, (professional corporations) will have an impact on the type of redemption agreement.
- Type of entity: If a family C corps, there would be concerns that a redemption would be treated like a dividend, if so, they would opt for a cross purchase, if that was an issue (attribution).
As you can see, depending on the situation and circumstances of the company, the type of Buy and Sell agreement is not a random decision. Planning and insight must be used. This comes down to asking the right in-depth questions when discussing the designing of the buy and sell agreement.
(1) Paul Hoods great book: Buy-Sell Agreements
If you would like to receive a free report on the 19 questions you need to ask yourself to have an efficient Buy and Sell Agreement, email me at: email@example.com, request: 19 questions. I will send this to you immediately,