Practical guidance on Buy / Sell Agreements
Erin Brown & Ryan Gray
What would happen if a co-owner of your business suddenly passed away, became bankrupt, retired or became permanently unable to work? What would happen to their interest in your business?
Consider the following scenario:
• X and Y are shareholders of a company, say ‘ExampleCo Pty Ltd’.
• ExampleCo Pty Ltd operates a successful business which has experienced recent market growth.
• X and Y have not entered into a Buy / Sell Agreement (or anything similar) and do not have corresponding insurance in place.
• Suddenly, Y passes away.
What happens to Y’s shares in ExampleCo?
If business co-owners do not agree otherwise, a business owner’s interest (e.g. shares in a company, units in a trust or a partnership interest) will usually pass to their estate on their death. This could result in a range of adverse implications including:
• interruption to the business (for example, in the scenario above, X will need to consider the interest of Y’s estate when making decisions at shareholder level);
• a forced sale of the business to provide finance for the family of the deceased co-owner; and
• the outgoing owner (or their estate) receiving an amount that is far less or more than ‘market value’ for their interest in the business.
These circumstances can continue for a long time causing significant damage to the business and its reputation. In the scenario above, this could spell disaster for X in circumstances where ExampleCo Pty Ltd was beginning to gain traction in the market.
Buy / Sell Agreements are contracts between the owners of a business to allow for the sale of a co-owners’ interest on the occurrence of a specified triggering event, such as their death, permanent total disablement, bankruptcy or retirement (Trigger Event). They are commonly used in conjunction with insurance that ensures the remaining owners have the capacity to fund the acquisition of the exiting owners’ interest.
There are a broad range of ways that a Buy / Sell Agreement can be structured (including in relation to who has the right to buy / sell a business interest on the occurrence of a Trigger Event and in whose name insurance will be taken out), each having different tax consequences. A poorly drafted Buy / Sell Agreement can have detrimental tax consequences for the continuing business owners and the exiting owner (or their estate).
While every business relationship is different, in our experience, it is usually easier for co-owners to reach a more reasonable position regarding the treatment of their respective business interests if appropriate action is taken before a Trigger Event occurs or becomes impending. It may become far more difficult to reach a fair agreement (or any agreement at all) in circumstances where an owner has decided (or is forced) to retire or otherwise exit the business because the continuing owners and exiting owner will have completely different objectives.
These issues can be largely avoided by investing time in implementing a business succession plan (including a Buy / Sell Agreement).