30/11/2011

A Buy/Sell Agreement is a business succession contract usually established between co-owners of a business to enable the business to continue on the involuntary departure of one or more of the owners in the event of their death, trauma, critical illness or total permanent disability. Typically, retirement or other voluntary dissolutions of the business are not covered under buy/sell agreements but come under other contractual arrangements.

Generally, a buy/sell agreement is designed to cover different types of small to medium size business ownership structures, such as family trusts, partnerships or companies.

The aim of the agreement is to ensure that:

• the business is preserved and can continue to be operated by the surviving owners;
• the family or estate of the departing co-owner receives a payment that reflects the agreed value of their equity in the business; and
• arrangements are established to ensure that a buy-out can be funded at the agreed value.

The operation of the agreement is triggered by the specified event and the buy-out of the departing co-owners’ business interest is usually funded by one or more insurance policies. Hence, the contract between the co-owners is usually comprised of a transfer (sale) agreement and a funding (insurance) agreement. 

The transfer part of the agreement is in two parts. One part establishes a sale agreement called a sell or put option so that the surviving co-owners are required to purchase the departing co-owner’s share of the business. The second part is a buy or call option that requires the family or estate of the departing co-owners to sell the business share to the surviving co-owners. 

The funding part of the agreement is intended to fund an agreed value of the business interests of the departing co-owner. The agreement will need to state whether this is the book value or the appraised value of the business at the time of the event, or alternatively, state how the value is to be determined.  Regardless of this, it usually obliges the co-owner to take out and maintain one or more insurance policies covering their death, disablement, illness and trauma. Premiums may be tax deductible, although tax advice should be sought on this aspect.

There are a number of obligations for co-owners entering succession agreements. Key among them is to:

• maintain all the insurance policies mentioned in the agreement, including paying any premiums as required under these policies;
• keep all personal documents such as Wills, Enduring Powers of Attorney and any superannuation fund death benefit nominations up to date;
• bring the buy/sell agreement to the attention of their attorneys and executors so they are aware of the contract obligations; and
• not act contrary to the obligations of the buy/sell agreement.

Generally, for tax purposes the contract is specified to be operating from the date of the trigger event. Clients will need legal and tax advice on what is the most suitable arrangement for them.

If you have any questions in relation to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.