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07/20/2021

Corporate Planning When Multiple Owners Are Involved

Stock restriction and buy-sell agreements are a critical element when organizing any business where multiple owners are involved. Generally, these agreements establish a procedure for purchasing a shareholder’s interests when they die, become disabled, or want to transfer their shares to a third party. A well drafted agreement deters unwanted transfers of ownership interests to third parties and helps to prevent conflict when certain extraordinary events occur. While such agreements can take many forms depending on the business structure and the intentions of the owners, the following provides a summary of the primary considerations that need to be analyzed in connection with the proper drafting of a stock restriction and buy-sell agreement.

Form of Purchase

Stock restriction and buy-sell agreements generally take one of the following forms: cross purchase agreement, redemption agreement, or a hybrid of the two. These forms differ in how they allocate the purchase options and obligations between the entity and the owners.

A cross purchase agreement is the simplest form of a buy-sell agreement, as it involves a contract solely among the business owners. Under this structure, a withdrawing owner agrees to sell their interest to one or more of the remaining owners. This form is most suitable for businesses with only a few owners. A redemption agreement provides that the entity itself will purchase the withdrawing owner’s business interest. Such a purchase may be funded by life or disability buyout insurance acquired on the owner. Hybrid agreements combine these two structures and allocate purchase rights and obligations between the entity and the remaining owners. Typically, the entity has the first option to purchase the interest. To the extent the entity does not exercise that option, the remaining owners have the right or the obligation to purchase the interest.

Nature of Restrictions, Trigger Events, Purchase Rights

A stock restriction and buy-sell agreement ordinarily includes a broad, general restriction on the transfer of ownership interests, so as to prevent a third-party from becoming an owner without the consent of the other owners. Sometimes the agreement may (depending on the circumstances) allow a transfer to specified “permitted transferees”, such as a spouse or child of a shareholder, a trust for the exclusive benefit of the shareholder, or a shareholder’s wholly owned corporation, all without obtaining the consent of the other owners. The stock restriction and buy-sell agreement would provide that transfers to impermissible transferees are null and void.


A stock restriction and buy-sell agreement also defines various trigger events, the occurrence of which gives rise to the purchase options or obligations under the agreement. Common trigger events include the death or disability of an owner, termination of employment (whether voluntary or involuntary), and the divorce or bankruptcy of an owner.
Upon the occurrence of a trigger event, the stock restriction and buy-sell agreement identifies the specific purchase rights and obligations implicated. Generally, the remaining owners or the entity will either have an option or an obligation to purchase the affected ownership interest.

Determining Price

The stock restriction and buy-sell agreement must clearly specify the method for valuing the business interest being transferred. Different processes for determining the value can yield different results. Common valuation methods include an agreed upon price (i.e. set prior to the trigger event even occurring), third-party appraisal and a formula method.

The simplest method of valuation is to have the parties agree to a set price, whether at an annual meeting or on some other regular basis. This method assumes the parties have a realistic idea of what the business is worth. Regular reviews of this price need to occur in order to avoid a “stale” (and potentially inaccurate) price.

A third-party appraisal of the business will generally provide an accurate assessment of its current value, however there are variables to consider with utilizing this method. Who chooses the appraiser, who pays for the costs of appraisal, and the appraisal method to be used must all be specified in the agreement in order to avoid future disputes.

The stock restriction and buy-sell agreement may also provide an agreed upon formula to determine the value of the interest (e.g. based on a multiple of sales or EBIDTA). This formula may be tailored uniquely to the business or industry at hand to determine a fair value. This method is advantageous because it does not require periodic updating, and ensures that the valuation will be made from current financial data.

Payment Terms and Funding Mechanisms

The payment terms for a purchase under a stock restriction and buy-sell agreement can specify payment in full in cash, or for the purchase price to be paid over time. The source of funding for the purchase depends on the specific trigger event, such as being funded by life insurance maintained on the lives of each of the owners, or in the event of disability, disability buyout insurance. In other cases, i.e. voluntary and involuntary transfers and termination of employment, a stock restriction and buy-sell agreement can provide for a lump sum payment of the purchase price, or installments over an extended period of time, with interest.

Additional Considerations

Stock restriction and buy-sell agreements can be as customized as the owners wish them to be. The important thing is that the agreement reflect the owners’ desires and intentions. Additional elements of stock restriction and buy-sell agreements include non-solicit and non-compete provisions applicable to the exiting owner, personal guarantees of the exiting owner’s purchase price payout, deadlock resolution mechanisms, call and put rights, and provisions to protect an entity’s S-election.

If you or your clients need a stock restriction and buy-sell agreement, or have questions about an agreement currently in force, please reach out to any member of the McGrath North Tax Group so we can provide you with the necessary guidance, and avoid future surprises and disappointment.