What Is a Buy-Sell Agreement?
A buy-sell agreement is a formalized business continuation plan that is
designed to provide for the orderly disposition or continuation of an
individual’s ownership in a business.
There are two basic types to consider:
- The Cross-Purchase Agreement
- The Stock Redemption
The buy-sell agreement allows the holder of a business interest to enter
into an agreement that will provide for the future sale of that interest
should death, disability or retirement occur.
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Under the terms of the buy-sell agreement, the specified buyer is legally
obligated to purchase the interest, and the interest holder or his/her
estate is legally obligated to sell the interest upon the occurrence of
one or more specified events.
A properly structured business continuation agreement has many advantages. It can:
- Control the value of the business for estate tax purposes and the estate
taxes due on the assets
- Ensure the continuity or orderly disposition of the business
- Protect the surviving owners from gaining an undesirable co-owner (such
as a member of the deceased interest holder’s family)
What Is a Cross-Purchase Agreement?
Under the Cross-Purchase Agreement, each interest holder agrees to buy
the interests of the other owners under the terms of the agreement. A
straightforward Cross-Purchase Agreement works well for a smaller business
where there are fewer than four owners.
Typically, with this arrangement, the co-interest holders personally own
life insurance policies on the lives of each of the other interest holders.
This generally becomes too complex when dealing with a large number of owners.
Funding can also be cumbersome, confusing, and potentially more expensive.
These difficulties have led to the creation of other types of Cross-Purchase
One example is a Trusteed Cross-Purchase Agreement involves the creation
of either a revocable or irrevocable trust. The trustee would be responsible for:
- Handling all the paperwork
- Owning and maintaining the life insurance policies
- Ensuring parties fulfill the terms of the buy-sell agreement
A Trusteed Cross Purchase Agreement can streamline the agreement and eliminate
complexity and expense.
Following are some advantages of a Cross-Purchase Agreement:
- The surviving interest holders receive a step-up in basis equal to the
price they paid for the withdrawing or deceased owner’s shares.
- Policy cash values are available to the owners, because they personally
own the policies on each other’s lives.
- The incorporated business does not have to own a life insurance policy
to fund the agreement, thus avoiding any corporate alternative minimum
tax on the death proceeds.