April, 2015
By Gary Pittsford, CFP®
President and CEO, Castle Wealth Advisors, LLC

Closely-held business stockholders need to understand how important a stock redemption agreement, or a buy-sell agreement, is to each stockholder and their families. Many business owners have prepared wills and trusts, which they believe are enough to handle the estate planning process. In reality, the stock redemption agreement could be more important for protecting the corporation and all of the stockholders.

The stock redemption agreement has several different names but is needed in a closely-held business in order to protect the company and the stockholders in case of anyone’s death, divorce, disability, personal bankruptcy, termination, retirement, or sale of stock. Normally, the largest asset for a closely-held business owner is the corporation he or she operates. The business stock needs to be protected so that it can be funneled directly into the will or trust that the attorney has created to handle the estate planning process, or purchased by the corporation.

Most closely-held business owners whom we work with do not have any stock redemption agreement. A small percentage may have an agreement prepared, but it was done many years ago and usually only covers the death of a stockholder.

Most stockholder agreements, which we read, provide for the transfer of stock in case of death, but those documents usually do not cover all of the other “trigger points” that I mention above. Disability is a possibility for many stockholders; the divorce of a stockholder could create problems not only for the company but also for the remaining stockholders. Each stockholder in a closely-held corporation should review their stockholder agreement to determine if provisions are in the document to cover not only the possible death of a stockholder, but also all trigger points.

There are primarily three types of agreements that could be used by closely-held corporations. First is the traditional stock redemption agreement which is an agreement between the corporation and the stockholders. If any stock is sold by a stockholder it would be purchased by the corporation with this type of document. Second is a cross purchase agreement which is an agreement between the stockholders individually and does not include the corporation. If any stock is sold then the other remaining stockholders have the responsibility to purchase the stock. The third agreement is typically called a hybrid stock purchase agreement. This agreement combines all of the best ideas from the first two and gives the company and the stockholders the most flexibility. With this document if any stock is to be sold then the corporation could purchase some of the shares and the other stockholders could purchase some of the stock, and if there is any stock remaining then the corporation would normally be required to purchase the shares that are left. This allows the stockholders and the company to consider any tax advantages and current financial strength that the company and the stockholders have at that time. By looking at all the parties connected to the process the best ideas can be implemented in order to do what is best for the company and the remaining stockholders.

Items to look for in every document:

  • Is there a price-per-share specified in the agreement, or is there a formula to calculate it? Is the formula still valid?
  • Is there a provision to allow the corporation and/or other stockholders to purchase the seller’s stock over a 5-10 year period using a promissory note?
  • Is there life insurance to cover the purchase of stock at death and is it enough?
  • In the case of stockholder disability, is there a provision to purchase the stock over time, and at what price per share? Disability should be defined in the document referencing the stockholders ability to do his job.
  • Does the agreement among the stockholders indicate that the price per share would be different depending on which trigger point occurs?

If the major stockholder is considering gifting stock to family members, a shareholder agreement, like the ones mentioned above, needs to be prepared in advance. Before stock is given to children, they should sign a shareholder agreement. If stock is given to a son-in-law or daughter-in-law, they would need to sign an agreement. If stock is sold to a key employee, they should also sign an agreement.

The stockholders of a closely-held corporation need to be certain that they understand the provisions in their current shareholder agreement. In addition, they should be comfortable with the price-per-share, or the formula that is currently in the agreement, which would be activated based on one of the trigger points. They should also be comfortable with the payout provisions for any of the possible purchasing events mentioned above. If the most important stockholder dies, perhaps the corporation is worth less. If a key employee leaves, that also can reduce the price of the stock. If the stock is being gifted to the younger generation, there would probably be some discount for lack of marketability and lack of voting control. There are many factors that affect the value of a closely-held corporation, and all stockholders need to be aware of how these trigger points influence the value of the company.

Gary Pittsford, CFP®, is President and CEO of Castle Wealth Advisors, LLC. Castle specializes in helping families and closely held business owners with valuations, succession planning, estate and income tax analysis and retirement income security. Castle’s senior partners work with clients throughout the country in making logical decisions that help them fulfill their personal and business financial goals. For more information visit www.Castle3.com, call 1-888-849-9559 or e-mail Gary directly at .