It is a contractual agreement between proprietors of a business, which facilitates the sale of an outgoing proprietor’s interests (e.g. Shareholding) once a specified event has occurred (e.g. trauma, death, Total disability).
As well as providing a mechanism for the sale of the interest in the business, the Agreement also sets a price at which the interest will be sold and a means to fund the payment of the purchase price. Due to capital gains tax and stamp duty considerations, it is common to have a Buy/Sell Agreement containing put and call options. Continuing proprietors are granted an option to purchase an outgoing proprietor’s interest in the business. In addition, the outgoing proprietor (or his estate) is granted an option to sell his interest to the continuing proprietors.
As mentioned, Term Life Insurance and Trauma Insurance are usually the most cost-effective way of funding such a purchase. As there may be capital gains tax consequences if there is a change of ownership in the policies, it is customary to either have the policies held by the individual proprietors or held by an insurance trust. It is not uncommon, however, to have policies cross-owned or jointly owned. Whichever method is used, care needs to be taken to ensure that the proceeds received will be tax-free.