A Buy and Sell Agreement is a legally binding contract that stipulates what will happen to a shareholder or partners ownership position in the event of a death, disability, divorce, shareholder/partner bankruptcy, or otherwise leaving the business. To be effective the language of the agreement must use definitive language in stipulating what actions must be undertaken in the event of one of the aforementioned events. Ambiguity or failing to craft clear definitions, will defeat the very purpose of a Buy/Sell Agreement, which is to provide clarity of purpose and action. The simplicity or complexity of the Buy-Sell Agreement should reflect the reality of the business with some due consideration for the future of the business. Like anything associated with an active business, expenditures, investments, personnel changes etc., require that the terms and conditions of a buy/sell agreement should be reviewed, with appropriate steps taken to amend the agreement to reflect the reality of your business.

Ultimately, a Buy/Sell Agreement is designed to ensure the survival of the business by avoiding outcomes from actions that could jeopardize the financial or management well-being of the business.

What should a Buy and Sell Agreement Include:

• A list of triggering events which could materially affect the well-being and control of the business, i.e., death, permanent disability, retirement, bankruptcy of an individual shareholder, marriage dissolution.
• A list of partners and their current ownership stakes
• A recent valuation of the company’s equity position and valuation methodology
• A funding instrument such as Life Insurance, a Sinking Fund, Disability Policy
• Tax and Estate Planning Provisions for both the Individual Shareholders or Partners and their families.

Benefit of a Buy and Sell Agreement

A Buy and Sell Agreement can assure a smooth transition of ownership and business resilience in the face of disrupting circumstances such as death or the departure of a significant shareholder or partner. As a legally binding agreement stipulating how ownership positions will be acquired by the remaining shareholders or partners, legal challenges or contestations can be either avoided or mitigated. The spectre of CRA contesting a shareholder transaction flowing from a poorly crafted buy/sell agreement, can have significant tax consequences. This agreement can help eliminate the risk to the business from including unwanted parties influencing your business. These agreements can help to preserve the value of the business by avoiding costly disruptions and wasted assets. Lastly, to the surviving family of a shareholder or partner, it can offer stability and reassurance during a particularly difficult time. An important consideration for small or closely held Incorporated Businesses or Privately Owned Un-Incorporated Businesses, if the Sole-Owner of the business dies and a successor owner (Key Person) would be financially challenged to buy the business, a Buy and Sell Agreement with this Key Person may preserve your family’s interest in the business and all that this business provides.

Types of Buy and Sell Agreements

There are two common forms of buy-sell agreements:

• • In a cross-purchase agreement, the remaining owners or partners purchase the share of the business that is for sale.
  • In a Corporate owned and corporate redemption, the business entity itself buys the deceased’s share of the business.

Valuation

Regardless of the method of affecting a Buy and Sell Agreement, a valuation that does not reflect the current value of the business, could shortchange the deceased heir’s, create taxation issues and lead to the contesting of these values by the family…an avoidable event. 

Most of the mechanisms for setting prices in buy-sell agreements generally fall into the following categories:

1. Formula based on the financial statements, such as book value, adjusted book value, a multiple or weighted average of historical earnings, or a combination of such variables
2. Structured negotiation among the parties
3. Third-party valuation

Valuations should be reassessed and amended. If there are funding arrangements i.e., Life Insurance, these should be updated where possible.

Funding a Buy Sell Agreement

What Are the Options to Fund Buy-Sell Agreements?

• Cash: You could fund buying and selling with cash.
• Another funding option is a sinking fund. (See Next Page)
• A Loan: You could borrow money from a financial institution assuming the nature of the buy sell triggering event does not impair your business and its’ credit worthiness.
• Installment Payments: Another method of funding the buyout could be installment payments to the heirs.
• Life Insurance: Finally, life insurance policies provide the most guarantees and certainty as a financing option. (See Next Page)

There are key considerations in any Buy Sell Funding arrangement; 1. Timelines, 2. Liquidity, 3. Volatility, 4. Tax Costs, 5. Tax Status and 6. Asset Effectiveness.

When a triggering event occurs the need for immediate cash is vital. Cash is king. However in any business cash is also the “blood” that makes business life possible. With any funding option the ready availability of money, especially when most businesses deploy their cash in some productive business pursuits, renders this as unlikely. Cash in a Sinking Fund that does accumulate in interest baring account, or active investment account, carries 2 fundamental problems; Income earned is taxed at a 50% rate and; Increasing values can jeopardize your small business tax rate. 

Borrowing money in a period of rising interest rates and perhaps the outright availability of credit for a business that has just encountered a material change in its share position and likely the loss of a key person, may cause a lender to seek unfavourable terms for your business well-being. 

A Share Purchase arrangement with an acquiring shareholder to fund the purchase of shares through declared dividends can be an effective arrangement, however this has the disadvantage of time. 

Insurance, both Life and Disability, can be a very compelling solution. Properly structured insurance policies can provide immediate cash in the event of a death or disability. If the deceased is a Key Person this can also help to overcome Lender concerns over the business’s viability. Life Insurance can also be a source of a very tax and investment positive method for establishing a Sinking Fund. Money can accumulate sheltered from tax. Further this money can be borrowed out of the Insurance policy and used to offset the buyout of a departing shareholder for reasons other than death. Cash Value Life Insurance can be a self adjusting valuation vehicle with rising payout and cash values that can accommodate for at least some of the valuation increases.

The preceding is not meant to be an exhaustive overview of all the factors that influence a well-crafted Buy Sell Agreement. Qualified and experienced legal advice is vital in the effective creation of these important documents. Further, valuation expertise is necessary to establish a current position. We work with a variety of established professionals, experienced in guiding you through the Buy Sell Agreement process. 

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