Buy-Sell Agreement Categories
The three types of Buy-Sell Agreements (BSA) are defined by the relationship between the parties to the agreement, i.e., the individual owners and their business entity.
Cross-Purchase Agreements are agreements between and among the owners of a business entity that requires the other owner(s) to purchase the interests of owner who has triggered the BSA. Cross-purchase agreements have common elements, including:
- Funded by life insurance owned by business owners on the lives of other owners.
- As the number of owners and the market value of the business rises, they can become unworkable.
- Typically individual owners are required to finance ownership shares not related to a death and they may not have that ability.
Entity-Purchase Agreements require the business entity (corporation, partnership or LLC) to purchase the owners’ interest when a trigger event occurs. The entity must then define or provide the funding to complete the transaction. The actual funding may come from the purchase of life insurance, financing from a third party or the selling owner(s), cash in the business, or some combination thereof.
Hybrid Agreements give the entity the “right of first refusal” to purchase the interests in when a trigger event happens. Should the entity decline to buy the interests, it may offer the shares to the other owners according to their current ownership percentage or to selected owners. If the entity has refused to purchase the interests initially and the other owners elect not to purchase the interests, the entity is required to purchase the interests. Funding for the purchase is often via a combination of self-financing by the business, notes payable from selling owners, and life insurance.
Proper business valuation is essential for Buy-Sell Agreements to operate the way they were intended. For more information about business valuation as an element of Buy-Sell Agreements, please contact Jim Leonhard at 916-800-2716 or jhleonhard@exitstrategiesgroup.com.
