Buy-Sell Agreements For Family Owned Businesses

A family-owned business is often far more than just the engine that drives the family's economic well-being. It is an entity to which family members may have an attachment that is nearly as much emotional as commercial. For that reason, a key concern of shareholders in a family-owned business is assuring that full ownership of the corporation remains within the family in the event of the death of a stockholder or upon the decision by a family member to liquidate his or her holdings.

Shareholders in a closely held family business may utilize a variety of estate planning strategies in order to assure continued ownership of the business by family members. The most common strategy is a buy-sell agreement under which all of the stockholders agree that, if a stockholder dies or decides to sell his or her shares, the remaining stockholders will have the right to purchase the shares from the decedent's estate or from the selling shareholder. The purchase need not be obligatory, and thus any shareholder would be free to opt out. Those stockholders electing to participate in the buyout would acquire the deceased or selling stockholder's shares pro rata, based upon their respective holdings.

Alternatively, an agreement may be structured whereby the corporation itself, rather than the remaining shareholders, has the right (or perhaps the obligation) to purchase the shares of the deceased or selling shareholder. Many jurisdictions, seeking to protect creditors, place restrictions on the power of corporations to purchase their own shares. For example, reacquisition of its own shares by a corporation may be subject to a statutory requirement that the corporation's purchase of its own stock can be made only to the extent of any accumulated surplus, or that after the purchase the corporation must be solvent.

A hybrid of these approaches is possible as well. The shareholders' agreement may provide that the corporation can buy its own shares to the extent of its accumulated surplus (or to the extent permitted under other statutory constraints), and any unpurchased shares would then be subject to a purchase option in favor of the remaining shareholders.

Whether shares of a family corporation's stock are to be purchased by the corporation or by the remaining stockholders, it is possible that neither will have sufficient, readily available funds to make the purchase. The problem of funding the purchase of deceased shareholders' stock may be addressed by purchasing life insurance policies on the lives of the shareholders. This is particularly important in the case of older and/or controlling shareholders.

Whatever approach is taken, a critical issue is valuation: At what price are the deceased or selling stockholder's shares to be bought? Market value would be a legitimate valuation, but it is often difficult to calculate. Family businesses are, by definition, closely held, with little or no liquidity in their stock. Thus, market value may be difficult or impossible to determine accurately. Book value has the advantages of relative ease of determination and apparent objectivity. However, care must be taken in situations where the book value may differ significantly from the actual economic value. This is true of companies with substantially appreciated assets that are carried on their books at acquisition cost. Additionally, situations may arise where the business's accounting methodology is questionable. Under a buy-sell agreement, an understated book value may cause a substantial hardship upon the estate of a deceased shareholder, while an overstated book value may unfairly hinder the efforts of the remaining shareholders to keep the business within the family.

As with any estate planning issue, always seek qualified legal counsel before pursuing a business buy-sell agreement.

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