One of the most devastating things that can happen to a business is the death of a significant shareholder, especially when it is a small partnership with only two or three owners. A Buy/Sell Agreement is a vital document that protects you from the confusion and potential for disagreement that can come if this unfortunate situation strikes.
There are three basic ways to structure a Buy/Sell Agreement to deal with the possibility of the death of a shareholder:
The Option Agreement
With an option agreement the surviving shareholders would have the right to purchase the interest of a deceased shareholder or partner at a specified price for a specified time period. If the opportunity were not taken, the deceased party’s estate could seek out a third party to purchase the interest. There are some problems with this approach. It does not guarantee a market for the interest to be sold, the current option holders might decline to exercise the option and it may be difficult to find another buyer.
Judy Rich and Shelley O’Brien were 50:50 shareholders in a manufacturing Corporation. Upon the death of either one of them, the other would have the choice of purchasing the appraised value of the other’s interest. Judy passed away and her shareholder interest was appraised at $200,000. Shelley declined to purchase Judy’s interest but another friend, Peter, decided to purchase Judy’s shares for $200,000. As part of the shareholder agreement Shelley would have to agree to the purchase.
Put-Call (Shotgun) Approach
In this approach, the deceased shareholder’s estate would offer to sell the interest to the remaining interested shareholders at a price and other terms set by the seller’s estate. The remaining shareholders would have the choice of accepting the offer or selling their own interests to the deceased seller’s estate on the same terms.
In other words, the initial seller’s estate could end up being required to buy out the interests of the remaining parties. This approach can make sense where deceased’s beneficiaries have the financial means to buy out the remaining shareholders and are prepared and able to run the business.
Yves, John, and Sarah were the three equal shareholders in YJS Inc, a metal fabricating firm. They had a Put-Call agreement in place whereby if one of them passed away, and the deceased shareholder’s estate decided to sell their shares then the others would each purchase a 50% share for their appraised value. Yves died and his estate offered to sell his shares to the others for $100,000. John and Sarah decided not to accept the offer but invoked the put-call agreement whereby Yves’ estate was required to buy their shares for $100,000 each. Yves’ estate was then the sole owner of the Corporation.
Binding Buy/Sell Agreement
In this approach the remaining shareholders are contractually obligated to purchase the interest of the deceased shareholder. This technique ensures that the estate will be guaranteed a price for their interest. It also ensures that the remaining parties will have control of the business without the possibility of any third party involvement.
It does, however, mean that the remaining shareholders will have to be able to come up with the funds to make the purchase.
Ian Blair was a 25% shareholder in Total Doors and Windows Inc. which had a Binding Buy/Sell Agreement in place. Ian died recently and his Executor invoked the Buy/Sell agreement whereby the remaining shareholders of Total Doors and Windows were required to purchase Ian’s interest from his estate at the appraised value of $250,000.
Who are the parties to a Buy/Sell Agreement?
There are two basic approaches in regards to the parties involved in a Buy/Sell agreement on death:
With this approach, the Corporation takes one side of the agreement and the shareholder’s estate takes the other side.
Criss-Cross or Cross Purchase Agreement
In this arrangement, the Buy/Sell agreement is between the individual shareholders/partners and the estate of the deceased.