A buy/sell agreement is a contract, usually entered into between the shareholders of a company (and often the company itself) which provides for the sale and transfer of shares of a shareholder (outgoing shareholder) to the other shareholders (continuing shareholders) if a specified event (buy/sell trigger event) occurs in relation to the outgoing shareholder.

Buy/sell trigger events

The buy/sell trigger events will usually include the death of the outgoing shareholder, but may cover other circumstances, such as the outgoing shareholder becoming totally and permanently disabled, or suffering serious illness or trauma.  If the outgoing shareholder is a company instead of a person, the buy/sell trigger events should apply to a specified person associated with the outgoing shareholder.  That person will often be someone involved in the management of the company to which the buy/sell agreement relates.

Buy/sell insurance

The buy/sell agreement will typically provide for insurance policies to be taken out and maintained, which cover each shareholder (or the shareholder’s associated person) for the relevant buy/sell trigger events, and that the insurance proceeds are used to fund the purchase by the continuing shareholders of all of the outgoing shareholder’s shares in the company on the occurrence of a buy/sell trigger event.  Consequently, the outgoing shareholder will cease to be a shareholder in the company, and not have any further involvement in its management or affairs.

Advantages of a buy/sell agreement

The key advantages of a buy/sell agreement are:

• to provide for funds to be available to enable the outgoing shareholder to be bought out.  Often, a buy/sell trigger event will happen unexpectedly, so the continuing shareholders may not otherwise be able to raise the necessary funds without having to sell the company or its business (which, in any case, may not be easy to do within a short timeframe);
• to enable the outgoing shareholder (or outgoing shareholder’s estate or family) to access the value of the outgoing shareholder’s shares in the company after a buy/sell trigger event has occurred; and
• to allow the continuing shareholders to own and run the company after a buy/sell trigger event has occurred in relation to the outgoing shareholder, without interference from the outgoing shareholder’s estate or family (who may not have previously been involved in the company’s affairs), or from any third party who might (in the absence of a buy/sell agreement) buy the outgoing shareholder’s shares.

In short, not having a buy/sell agreement in place can lead to conflict among shareholders and potentially adversely impact the company and its business, due to lost time, unnecessary distractions, and potential litigation.  

Key questions when preparing a buy/sell agreement

The following are some key questions shareholders should ask themselves before deciding on the terms of a buy/sell agreement:

• What are buy/sell trigger events? The answer to this question is likely to depend on the ability to obtain insurance cover for each shareholder (or its associated person) for the relevant events, and the cost of that insurance cover.  For example, it may not be possible to obtain the same kind and level of cover for all shareholders (or shareholders’ respective associated persons), or the same kind and level of cover for all of them at a reasonable cost.
• How will the insurance policies be held?  There are a number of options, including each shareholder holding their own individual policy, each shareholder taking out policies covering the other shareholders (or their associated persons), or the company holding the policies.  Each of these options has advantages and disadvantages, and the approach taken will depend on the parties’ particular circumstances.
• What is the amount to be insured?  Ideally, the insured amount should be sufficient to cover the value of each shareholder’s shares, but the cost of such cover may be an issue.  Furthermore, the value of the company’s shares is likely to fluctuate over time, and therefore the agreement should provide for periodic valuations of the company’s shares and reviews and variations of insured amounts.
• What happens if the insurance proceeds are greater or less than the value of an outgoing shareholder’s shares?  If the insurance proceeds are insufficient to cover the outgoing shareholder’s shares, the agreement could provide that the loss represented by the shortfall is to be borne by the outgoing shareholder (or their successors), or that the continuing shareholders must fund the shortfall, perhaps over a period of time.  The entitlement to any excess insurance funds should also be addressed in the agreement.

Interplay with shareholders’ agreements

A buy/sell agreement is generally a stand-alone document, but if there is a shareholders’ agreement in place for the relevant company (or the shareholders intend to enter into a shareholders’ agreement), then it may be preferable to include buy/sell clauses in the shareholders’ agreement instead.  Otherwise, care will need to be taken to ensure that there is no conflict or inconsistency between the terms of the shareholders’ agreement and the buy/sell agreement.

Other business structures

Buy/sell agreements can also be used for business structures other than companies, such as unit trusts and partnerships.  Most of the above points will apply equally to all buy/sell agreements, regardless of the business structure being used.

Seek professional advice

Buy-sell agreements can be complex, and the requirements of each business are unique. It is therefore important to seek legal advice before deciding on the terms of a buy/sell agreement and entering into one.  There are also tax implications for a company and its shareholders associated with buy/sell agreements, and we therefore recommend that parties seek tax advice from their accountants or other tax advisers before implementing a buy/sell agreement.  In addition, obtaining advice from an insurance broker or consultant on the type and level of insurance cover available, and related premiums, is recommended.

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For more information, please contact any member of the Sierra Legal team, whose contact details can be found here (LINK).

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