Academic journal article Journal of Accountancy

Make the Most of Buy-Sell Agreements: These Complex Contracts Solve Many Problems

Academic journal article Journal of Accountancy

Make the Most of Buy-Sell Agreements: These Complex Contracts Solve Many Problems

Article excerpt

EXECUTIVE SUMMARY

* BUY-SELL AGREEMENTS LET OWNERS, or shareholders and a corporation, agree to the terms and conditions of a future sale to smooth the transfer of an ownership stake under certain triggering events. They also provide a framework for establishing the purchase price of a business interest when an owner leaves or dies.

* CPAs CAN HELP CLIENTS UNDERSTAND the details of buy-sell agreements and work with a team of professionals (such as an attorney, an insurance agent and an ABV) to ensure an agreement is correctly prepared. Misunderstandings over the interpretation of terms often are at the core of owners' disputes about the value of their respective interest.

* TYPICAL BUY-SELL AGREEMENTS will specify the type of the agreement, triggers that cause a mandatory or an optional buyout, a determination of the appropriate valuation date imposed by the agreement, the payment terms of the buy-sell obligation, methods by which the agreement will be funded, noncompete agreements between the parties as well as transfers of an owner's interests permitted and prohibited by the agreement.

* ALL TYPES OF CLOSELY HELD BUSINESSES can use buy-sell contracts. The two most common types, cross-purchase and redemption agreements, typically use insurance to fund the purchase of ownership interests.

* TO DRAFT AN AGREEMENT that satisfies all owners and precludes future conflict, the owners need to understand their goals, the transaction's ramifications and their options. Each party has rights, obligations, tax considerations and financial consequences. CPAs can help facilitate discussion to clarify owners' choices.

Business owners often ask CPAs about how useful buy-sell agreements can be for them. The answer is "very." A buy-sell contract helps solve many problems at an unsettled juncture. It lets business partners, or shareholders and a corporation, agree to the terms and conditions of a future sale. That can smooth the transfer of ownership interest under disruptive circumstances that may include a partner's death, retirement, termination of employment, loss of a professional license, disability or divorce (or the transfer of ownership to a spouse), bankruptcy, insolvency or receipt of a third-party offer to purchase the business. Having an agreement gives an owner a ready market for his or her business interest, resolves estate liquidity issues, provides a framework for establishing the purchase price of the interest and reduces disputes. By ensuring transition stability, a buy sell contract also improves morale among the owner group.

CPAs can help clients understand the details of these agreements to better work with legal and other professionals to draft a buy-sell contract. Where lack of an agreement or misunderstandings over the interpretation of its terms are the basis of owner disputes about the value of their respective stake in a company, CPAs also help resolve disagreements and determine whether a party ,nay be subject to a penalty.

Typical buy-sell agreements will specify

* The type of agreement.

* Triggering events that cause a mandatory or optional buyout.

* A definition of the valuation date imposed by the agreement.

* A baseline purchase price and the terms of payment.

* Methods by which the agreement will be funded.

* Noncompete agreements between the parties.

* Transfers of an owner's interests permitted under the agreement.

* Transfers prohibited by the agreement.

Note: It is not necessary that the same agreement apply to all owners of an entity.

TYPES AND TRIGGERS VARY

Buy-sell agreements apply to all kinds of organizations including C corporations, S corporations, limited liability companies, joint ventures, limited partnerships and general partnerships. Depending on the nature and ownership of an entity, types and triggers will vary, but every effective agreement should anticipate funding, be kept up to date and provide for a procedure to determine the purchase price. …

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