Sylvia Walker | 04 March 2024
Sylvia Walker is a financial planner at Andrew Prior Consultants. She spent many years in a senior management position at Old Mutual before venturing out of the corporate world. She is also a freelance finance writer and author of several non-fiction books.
A buy-and-sell agreement specifies how the remaining shareholders in a company will purchase the shares of a co-shareholder if they die or become disabled. In addition to the agreement, shareholders typically make provision for funding the purchase of the shares through life insurance policies or, if one of the shareholders is uninsurable, other forms of funding.
If the agreement isn’t watertight, it can lead to disputes, unnecessary taxes, and a slew of other negative consequences for the business and family of the life insured.
First step is to ensure that the agreement is in writing. Meera Naidoo, head of legal support at SanlamConnect, says a verbal agreement is a valid contract. However, proving the existence and the terms of the agreement may be a challenge.
“The surviving partners will have to provide evidence as to the intended outcome, which may or may not align with the deceased partner’s wishes,” she explains. “So to prevent any confusion, the agreement should always be in writing.”
When drawing up the agreement watch out for these pitfalls in the wording of your buy-and-sell agreement:
An unsigned agreement isn’t valid. When a shareholder dies and the proceeds of a policy set up to fund a buy-and-sell agreement are paid to the partner, it will be hard to prove that the partner had a legal obligation to acquire the insured partner’s shares.
“The policy owner could potentially use the funds for whatever they want to, leaving the life insured’s family vulnerable,” Harry Joffe, head of legal services at Discovery Life, says.
Naidoo also warns that if the business shares are held in a trust, the agreement must be signed by all the trustees. Alternatively, a resolution authorising a trustee to contract on behalf of the trust must be signed prior to signing the agreement.
“Also attach the share certificate to the buy-and-sell agreement to avoid any future uncertainties,” she adds.
When companies are set up, shareholders should set up a shareholder’s agreement. These seldom deal adequately with what happens when a shareholder dies or wants to exit, and typically buy-and-sell agreements are set up after the company is formed.
However, if the buy-and-sell agreement contradicts the shareholder agreement, it can lead to problems. According to Joffe, most shareholder agreements contain a clause allowing for the buyout of shares on death or disability. To avoid complications, this should be removed or amended when a buy-and-sell agreement is signed, he advises.
“The shareholder agreement will always supersede the buy-and-sell agreement,” Naidoo explains. “The specific provisions that do not align will be null and void in the buy-and-sell agreement.”
The method used to value the business is the foundation for future valuations and should be attached to the buy-and-sell agreement, Sue Cogswell, financial planner at BDO Wealth Advisors, says.
Joffe believes the valuation should be updated at least every two years, as it will change over time. He suggests attaching an annexure to the agreement, which can be updated.
“This means that the entire agreement doesn’t have to be signed every time,” he says. “But the problem is that frequently the valuation is put off as it is viewed as an administrative burden.”
The events that trigger the agreement to buy out a shareholder’s shares need to be agreed upon by all the partners and specified in the agreement. 
Naidoo says an example of how this can go wrong is with a life insurance policy that also pays out a disability benefit, but the buy-and-sell agreement only addresses the death of the partner.
“In this case, the disability benefit would pay out if the life insured is disabled, but the other partners would not be required to buy their share of the business, which may be problematic,” she says.
Cogswell points out that buy-and-sell insurance policy premiums are often paid by the company even though the policy is owned by the other partners. “The accountant then collects the premiums from each partner according to their share of the life policy and may allocate them to their respective loan accounts,” she explains.
This is based on each partner’s share in the business. “If it’s not done accurately or regularly updated, there is a risk that the South African Revenue Service (SARS) will decide that the life insured paid premiums on his or her own life, making the proceeds subject to estate duty,” Cogswell notes.
“There could also be fringe benefits tax consequences,” Joffe adds.
The buy and sell agreement must consider the possibility that all the partners could pass away at the same time, Naidoo says.
Decisions need to be made as to whether the respective estates will keep the proceeds of the policies or whether this will be used to buy the other partner’s shares.
The business may cease for other reasons, such as insolvency or a dissolution of the partnership, and some issues need to be included in the agreement.
It’s important to decide what would happen to the policies: would they be ceded to the life insured, would the life insured buy his or her policy from the other partners, or should the policies be cancelled?
“If this is not specified, the policy owner can continue paying the policy as an insurable interest is only required at the inception of the policy,” Joffe explains.
According to Naidoo, there may also be a one-sided buy-and-sell agreement in place, where the intention is for an employee to buy the company on the owner’s death. The employee takes out a policy to fund this, but you need to consider what would happen if the employee was dismissed.
“Will the policy be ceded to the life insured, or what will be the outcome?” she asks.
Buying the wrong type of disability cover, such as broad general disability cover, can lead to complications. 
“The downside of disability cover is that the life insured must sell their shares if the event occurs,” says Joffe. “They have no choice.”
Cogswell adds that some people may want to continue working in the business because they’re able to do so despite their disability. Selecting the right type of disability cover prevents these issues from arising.
Joffe also emphasises the importance of matching the definitions of disability in the buy-and-sell agreement and policy contract.
There is always a risk of being over or underinsured, warns Cogswell. “The premiums and insured value will increase over time, so the policy benefits will never perfectly match the value of the business,” she says.
If you’re underinsured, the surviving partners won’t have enough money to purchase the business share, so they will owe money to the life insured’s family, which is not ideal. According to Joffe, the agreement should specify how this shortfall will be paid over time, adding that interest does not have to be charged.
Naidoo says that the agreement should also include a provision for a surplus of proceeds. “Specify whether any excess will be paid into the estate or retained by the policy owner,” she mentions. “The tax implications also need to be considered. “
If you and your spouse own a business together, guard against enrichment caused by leaving your shares to your spouse as well as entering into a buy-and sell agreement backed by a policy.
The proceeds of the policy will be considered unjust enrichment, Naidoo says. “You can insure each other’s lives and buy each other’s shares; just don’t bequeath the same shares to them in your will as well,” she says.
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BUY-AND-SELL AGREEMENT TIPS
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The agreement should reflect the wishes of all parties involved, not just one partner.