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 that when a shareholder leaves the business, whether due to retirement, disability, death, or another reason, the departing shareholder’s shares will be purchased by the company. By buying out the departing shareholder, the company effectively increases each shareholder’s proportional holdings, ensuring that no shareholder acquires additional power or a majority ownership interest in the company.
Stock redemption agreements are formally written and can be prepared years in advance of shareholders’ departure. They are constructed in order to avoid issues related to compensation of the departing member and to determine which remaining shareholders will purchase the departing member’s shares. Stock redemption agreements are best implemented within businesses where the current shareholders each hold an equal number of shares. They assure all shareholders that no minority shareholder will purchase the departing member’s shares and thereby gain majority ownership of the business upon a shareholder’s departure. These agreements also give shareholders the assurance 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 in advance, and the funds for that compensation are 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 that 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 bona fide 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 to avoid 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 be 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 that they will be compensated upon departure from the business. They assure shareholders that they will not be blindsided by another shareholder buying the departing member’s shares and thereby becoming the majority owner of the company. They also assure shareholders that no third party will enter into the business without their approval.
Fredrick P. Niemann Esq.
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 of experience and looks forward to assisting you and your business. Mr. Niemann can be reached at (732) 863-9900 or by email at fniemann@hnlawfirm.com. Please contact him today.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Business Law Attorney