Fair vs. Equal Strategies for Asset Distribution

There are many different types of purchase agreements. We will discuss the pros and cons of the following purchase agreements: right of first refusal, first option to buy, option to purchase/option to buy, and buy-sell agreements.

The right of first refusal is a legal document that provides the person holding it the right to purchase property before anyone else. A right of first refusal requires the seller to provide documentation of a legitimate offer to purchase to the person who owns the right of first refusal. The person with the right of first refusal has the opportunity to say they will match the offer and buy the property or they can refuse it and the property can be sold to the person who made the original purchase offer.

Pro: The right of first refusal allows the seller to ask fair market value of the property if they want. The right of first refusal also allows the holder of the right the opportunity to purchase the property before those without the right.

Cons: This type of agreement provides no price protection to the person with the right of first refusal. The right of first refusal does not require the owner to sell the property. The property may never be for sale during the potential buyer ‘s lifetime or when they wish to and are financially able to do so. Right of first refusal requires the involvement of a third party to make a legitimate offer. 

This can create disputes, for instance, from an unhappy potential third party. It has the potential for abuse in regards to whether the price offered was legitimate. Right of first refusal can also impact the seller’s value because a third party buyer may be unwilling to make an offer when they know that the right of first refusal holder will be able to match it.

The first option to buy sounds similar to the right of first refusal but is not the same thing. The first option to buy names an heir or heirs who have the right to purchase the property if they desire. It can be granted like the right of first refusal and can be “triggered” by events defined in the document, including but not limited to the death of the owner. There is often a time period in which the sale must take place. The document can specify if the property is to be sold at fair market value, at a set price, or a formula is provided to determine the price at something less than fair market value.

Pros: This may provide enough protection for the on-farm heir to retain the business property if they have the cash or ability to borrow.

Cons: Depending on how many heirs there are, the on-farm heir may not receive enough of the assets to leverage a loan to purchase the assets or interests held by the others.

An option to purchase/option to buy is another possibility. This option gives the buyer the right to purchase property according to agreed-upon terms and conditions within a set time frame.

Pros: This option gives the buyer more control, as they own the option to purchase but are not required to exercise that option.

Cons: The property may never be for sale during the potential buyer ‘s lifetime or when they wish to and are financially able to do so.

A buy-sell agreement is a document that allows, or in some instances, requires, the seller to sell and the buyer to buy the assets outlined in the agreement. The buy-sell agreement is triggered by events defined in the document, such as death, disability, termination of employment, retirement, or sometimes a divorce. The agreement outlines a set of procedures or rules for determining the purchase price, paying the purchase price and time frames for the process. Life insurance can be obtained to assist in payment of the purchase price in the case of death as a trigger (sometimes referred to as being “funded” with life insurance), but usually payment terms (for instance, requiring the seller take payments over time) will need to be set for triggers other than death or if the life insurance has expired or is no longer sufficient to cover the purchase price. Many times the buy-sell agreement has language that provides a discounted price because it is a closely-held business, to reflect the lack of marketability of the interest and/or that the portion at issue represents a minority interest in the business. A closely-held business is one that is owned by a small number of people who typically have a common interest in the business (i.e., family members).

Buy-sell agreements can provide that the other owners are the “buyers” (sometimes referred to as “cross purchase”), that the entity itself is the buyer (sometimes referred to as a “redemption”), or alternating opportunities between the entity and the individual owners. Many times a buy-sell agreement is included in entity documents, such as the corporation by-laws, the LLCs operating agreement or the partnership agreement. However, buy-sell agreements can also be standalone documents between parties, such as owner-employee agreements.

Pro: The agreement is designed to guarantee that ownership and control of the business stays in the family. The agreement also ensures the seller has a buyer when they want to leave the business.

Con: If not property planned, funding the agreement can still be difficult

Purchasing agreements need to be considered by both sides to be enforceable. Therefore, these rights outlined above, unless granted in an estate plan document, are going to require either a payment, need to be tied to another business deal, or require the holder of the right to give something up in order to receive this benefit. It is common for the right of first refusal to be granted as a part of a sale or a lease arrangement. For example: “I’ll buy this 40 acres from you now for $x, on the condition you give me a right of first refusal on your other acerage.”