8992 / What is a buy-sell agreement?

Buy-sell agreements are often used in business succession planning where the business is owned by a relatively small group of owners who would otherwise have a limited market in which to sell their business interests (most commonly represented by their stock in the enterprise). A buy-sell agreement can provide the remaining shareholders or co-owners with the option of purchasing the business interests of a deceased or withdrawing co-owner before the business interest is sold to a third party. Business entities such as closely held corporations ( Q 8951), LLCs ( Q 8977), and partnerships ( Q 8927) frequently rely upon buy-sell agreements when creating future business succession plans. A buy-sell agreement is essentially a contract to buy and sell a departing business owner’s interests in a business at some point in the future, usually upon the occurrence of one or more specified events. The most common of the events that can trigger the repurchase are the stockholder’s death or, if also an employee, retirement or the voluntary or involuntary termination of employment.¹

A buy-sell agreement is typically structured as either a cross-purchase agreement or a redemption agreement. A cross-purchase agreement is an agreement among co-owners to purchase each other’s business interests upon the death, or other withdrawal from the business, of one or more owners. These agreements typically specify a predetermined purchase price and, in some cases, are funded by life insurance purchased to insure the lives of the various business owners.

The typical buy-sell agreement also specifies the method to be used to determine the repurchase price of the shares, selecting from such options as an agreed price with periodic revisions, a formula price based on book value or capitalization of earnings, or third party appraisal or arbitration.

A redemption agreement allows the business entity to purchase the interest of a deceased or withdrawing business owner upon the occurrence of previously agreed upon “triggering events.” See Q 8999 for a discussion of the different considerations that apply depending upon whether the agreement is structured as a cross-purchase or redemption agreement.

It is also possible to structure a buy-sell agreement so that it combines features of the cross-purchase agreement and redemption agreement.² In addition, the buy-sell agreement can involve a contract to sell to a third party or another entity.

See Q 8993 for a discussion of the importance of buy-sell agreements in business succession planning. Q 8994 outlines the primary methods for funding a buy-sell agreement and Q 8995 outlines the use of life insurance in funding the agreement. Q 8999 to Q 9001 provide an in-depth analysis of the differences between the redemption and the cross-purchase forms of agreements.