Introduction

A buy/sell agreement is also known as a buy out agreement, a business succession agreement or a business will. 

It deals with the sudden departure of a “key person” from the business and their share of the business entity ownership.

This sudden exit can be contrasted to a transactional and negotiated exit that is instead covered under a shareholders’ agreement.

A buy/sell agreement’s trigger events should be deemed under the shareholders’ agreement to override the shareholders’ agreement in the event that both are enlivened.

Unlike a shareholders’ agreement, which is commercial and transaction driven, a buy/sell agreement is driven by: 

• taxation (particularly by its choice of structure described below)

• business succession insurance (for which its effectiveness is reliant upon the taxation structure)

A buy/sell agreement is “triggered” upon any number of defined “exit events” which can typically include:

• death

• total and permanent disablement (TPD)

• trauma

Ultimately, the purpose of a buy/sell agreement is to plan for the orderly transfer of “ownership” (e.g. shares or units or a partnership interest) of the business by the departure of the key person who owned the shares/units.

Apart from the business having to replace the key person suddenly, the remaining business owners will need to deal with transfer of the ownership interest of the departed key person, which could otherwise be controlled by their estate (e.g. their spouse or relative as executor).

Directorship as a “personal office” will cease upon death, and the company’s constitution would deal with loss of directorship voting capacity following TPD or trauma.

Control of the key person’s ownership voting power by their estate may be particularly burdensome on the business where that key person held 50% or more of the ownership of the business.

Having a buy/sell agreement in place early, with appropriate insurance, will trigger the insurance payout upon the insured trigger event to pay for the remaining business owners to buy out the departing key person’s shares or units in the business, completing a clean exit.

Insurance

Insurance and taxation are the key drivers behind the buy/sell agreement. And these are inter-reliant upon each other.

A number of insurers offer specific products to cater for buy/sell agreement insurance (e.g. AIA, Clearview, MLC).

T Legal is not licensed as a broker to recommend any particular insurance provider, but broker names can be provided upon request.

Taxation Structure

Your adviser will be your first point of contact to advise on choosing from the various buy/sell agreement structures and an insurance provider.

Broadly, the buy/sell agreement can take the following known forms, for which the first “self insured” is the most widely used:

• self-insured (each business owner takes out their own insurance policy)

• cross-insured (the business owners insure each other’s ownership interest but not their own)c

• insurance trust (a separate trust owns the insurance policy)

• SMSF self-insured (a variant on the self-insured model - where the business owner owns an insurance policy through their SMSF)

The insurance policy will pay out a pre-determined value to correlate with the valuation of the business owner’s ownership interest (e.g. 20%, 50%, 75% etc) of the business.

The insured events can include the following which will be the trigger or “exit events” under the buy/sell agreement:

• death

• total and permanent disablement (TPD)

• trauma

Upon one of the trigger exit events occurring, the insurance payout will be triggered to the business owner or their nominated insurance beneficiary.

Immediately before, the buy/sell agreement will grant a “call option” and a “put option” to exercise the forced sale of the exiting business owner’s ownership interest in the business to the remaining business owners.

Either the exiting business owner’s legal personal representative or executor may exercise the put option to forcibly sell that ownership interest or the remaining business owners may exercise the call option to forcibly buy out that ownership interest - which should be funded by the insurance payout.