Selling Your Interest in the Company by Use of a Redemption Agreement
A REDEMPTION AGREEMENT ALLOWS A DEPARTING SHAREHOLDER, PARTNER OR LLC MEMBER TO SELL OUT THEIR INTEREST IN THE BUSINESS TO THE COMPANY INSTEAD OF THEIR CO-OWNER
Another common type of buy-sell agreement is the “stock redemption” agreement. This is an agreement between shareholders in a company that states when a shareholder leaves the business, whether it be due to retirement, disability, death, or other reason, the departing members shares will be bought by the company. With the company buying out the departing shareholder, this effectively increases the proportionate holdings of each shareholder within the business, assuring that no shareholder acquires any more power or a majority ownership interest in the company.
Stock redemption agreements are formally written and can be prepared years before the departure of shareholders. They are constructed in order to avoid issues related to compensation of the departing member and which remaining shareholders will purchase the departing members’ shares. Stock redemption agreements are best implemented within businesses where the current shareholders each have an equal amount of stock in the company. They assure all shareholders that no minority shareholder will purchase the departing member’s shares and thus take a majority ownership of the business upon a shareholder’s departure. These agreements also give shareholders the security of knowing that no third party will purchase the shares and become a member of their business.
A major benefit of redemption agreements is simplified funding for the departing member. The compensation for the departing member is agreed upon beforehand and the funding for such compensation is made available at the time of the agreement. This avoids normal liquidity issues associated with a departure. When you leave the business, you are paid the money immediately, without any questions asked.
Like other buy-sell agreements, stock redemption agreements can set a predetermined value for the company for tax purposes, which is useful for companies which are only going to increase in value. However, for the government to honor such a predetermined value, three strict conditions must be met:
- The agreement must be a bonafide business agreement.
- The agreement cannot be a device to transfer the business to members of a decedent’s family for less than full and adequate consideration.
- The terms of the agreement must be comparable to similar agreements entered into by non-parties.
These conditions prevent shareholders from using stock redemption agreements as a way to get around paying gift tax or reduced income/estate taxes.
Stock redemption agreements should be prepared by an experienced business law attorney. Why? Because there are numerous guidelines that must followed in order to be recognized. If written properly, they can be incredibly beneficial to any business. They assure shareholders that they will not have to find a buyer for their shares and will be compensated when they depart from the business. They assure shareholders that they will not be blindsided by another shareholder buying a departing members shares and thus becoming a majority owner in the company. They also assure shareholders that no third party will enter into the business without their approval.
If you have questions regarding a stock redemption agreement for your business succession planning, please contact Fredrick P. Niemann, Esq., a knowledgeable and practical NJ attorney. He has over 40 years’ experience and looks forward to assisting you and your business. Mr. Niemann can be reached toll-free at (855) 376-5291 or by email at firstname.lastname@example.org. Call him today.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Business Law Attorney