A private sale agreement refers to a legally binding agreement that establishes the price at which an entity may sell their business interests. They are also known as a:

  • Buy-sell agreement.
  • Buyout agreement.
  • Business continuation agreement.

Such an agreement protects the business from loss of revenue and can be used to cover the expense of finding and training replacements.

They can be created as separate agreements, or certain provisions (that address buy-sell issues) can be included in the operating agreement of a business.

No matter the format used, the agreement must clearly identify potential buyers, the conditions governing the sale, and any limitations or restrictions.

By agreeing to the terms of the agreement, owners enter into a contract that transfers their business interests to potential buyers once a specific event occurs. Examples of such events include resignation or termination of employment, loss of professional license, criminal conviction, personal insolvency or bankruptcy, retirement, long-term disability, and death.

Uses of a Buy-Sell Agreement

A well-drafted buy-sell agreement creates a ready market for the disposal of business interests, establishes a mutually beneficial price, and provides the cash needed to complete the purchase of the business.

Buy-sell agreements are particularly useful in estate planning since they can be used to fix the purchase price of the business as its taxable value. If the agreement indicates death as the triggering event, it can help reduce the burden of estate tax on the deceased's heirs.

The agreement also provides an estate with ready liquidity for payment of taxes and expenses since the funding is typically arranged during the execution of the agreement.

Cross-Purchase Agreement

This type of agreement provides key employees with the opportunity to buy off the business interests of a disabled or deceased key employee. Each employee takes out an insurance policy on every other key employee. To be effective, cross-purchase agreements are usually used in small companies with a negligible number of key employees.

Stock-Redemption Agreement

These are formal agreements between a business and each of its key employees, where the business agrees to buy the stock of said employees in the event of their death. The agreement usually stipulates that the key employees exchange their ownership interest for an equivalent value in cash. A stock-redemption agreement establishes the market value for the company shares held by employees.

Determining the Purchase Price

Buy-sell agreements should explicitly state the purchase price or stipulate a formula for determining the purchase price. If the agreement does not stipulate the purchase price in advance, it could result in lawsuits and lengthy disputes when the event that triggers the buyback of ownership interests occurs.

For buy-sell agreements involving family members, proof should be provided that the transaction was entered into for legitimate business purposes and is equivalent to one between unrelated people.

Once the value of the ownership interest has been determined, financial advisors and the other parties to the agreement should look for trigger events that are appropriate for the business situation as well as the best way to fund the transaction.

This usually includes the following.

Set Aside Funds

The parties to a buy-sell agreement could agree to set aside certain amounts to fund the transaction as long as the amount is easily accessible. In this instance, the business owner(s) determine the amount needed to cover the cost of the purchase. Such funds must be readily available throughout the life of the company; however, such a strategy may be unfeasible especially when the company is experiencing a fiscally tough period.

Loans

Businesses could decide to borrow enough money to buy out the ownership interests of a deceased or retiring key employee. However, the loss of the key employee could impact the business' ability to secure the loan and could place additional financial stress on the business.

Life Insurance

One of the more viable options for funding a buy-sell agreement is purchasing a life or disability insurance policy. The agreement is funded through premium payments to the insurance policy. The premium for a life insurance policy is determined by a number of factors including:

  • Type and amount of insurance purchased.
  • Health and age of the insured.
  • Cost and availability of life insurance.

Life insurance policies also incur additional expenses such as mortality and other charges.

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