If your business partner died tomorrow, who would you be in business with next week?
Their spouse? Their kids? A probate attorney representing an estate that has no earthly idea how to run a company?
In many cases, the unspoken assumption is usually something like: we’ll sort it out when the time comes, like reasonable people. Except grief and inherited stock don’t tend to lead to sound reasoning — they lead to lawyers, disagreements, and a business that grinds to a halt.
If you don’t have an answer to who you’d be in business with next week, you don’t have a plan. You have a hope.
A buy-sell agreement is how you can turn that hope into a plan, while everyone involved is still rational and nobody’s under duress. Here’s what it needs to include.
What Is a Buy-Sell Agreement?
A buy-sell agreement is a legally binding contract among business co-owners (or between owners and the business entity itself) that governs what happens to an ownership interest if a triggering event occurs. It answers three questions in advance: who can buy, who must sell, and at what price.
A properly designed buy-sell agreement:
- Prevents ownership from landing in the hands of someone nobody intended to be a business partner.
- Gives surviving owners a clear, pre-negotiated mechanism to maintain control of the company.
- Gives a departing owner, or their family, a contractual path to liquidity for an asset that’s otherwise notoriously hard to sell on short notice.
Without one, all three of those things are left to chance.
Common Triggering Events for Buy-Sell Agreements
There are several events to account for in a buy-sell agreement:
- Death. A standard trigger that’s often paired with a life insurance policy meant to fund the buyout. A common problem, though, is that the policy was purchased years ago, the coverage amount was set against an old valuation, and nobody’s checked if it still covers what the business is worth today.
- Disability. A disabled owner who can no longer contribute still owns a piece of the company and still needs to be bought out fairly, without the business collapsing under the obligation.
- Divorce. An ownership interest may be treated as marital property even when only one spouse holds legal title. Without coordinated transfer restrictions or buyout provisions, divorce can create claims against the value of the business and, in some circumstances, ownership complications.
- Voluntary departure. An owner who simply wants out — for retirement, a career change, or a falling-out with other owners. Without agreed-upon terms, this can turn into a protracted negotiation.
- Termination of employment. Relevant when ownership and active employment are linked, which is common in closely held businesses. What happens to someone’s equity if they’re fired, or if they quit?
- Bankruptcy or financial distress. Agreements can include transfer restrictions or purchase rights intended to limit disruption if an owner’s interest becomes exposed to creditors. Bankruptcy law can override certain contractual restrictions, however, so these provisions should be drafted carefully with counsel.
- Retirement. A planned, expected trigger — but “expected” doesn’t mean the process is automatically and plainly outlined.
Structuring the Agreement: Cross-Purchase, Entity-Purchase, and Hybrid
There are three primary types of buy-sell agreements, and the right one depends on the number of owners and how the business is organized.
Cross-Purchase Agreement
Surviving owners directly purchase the departing owner’s interest from one another. Each owner typically holds a life insurance policy on every other owner, funding their portion of the eventual buyout. This works cleanly with two owners — one policy each, pointed at each other. More owners complicate matters: five owners would equate to twenty separate policies to fund every possible combination, which is why traditional cross-purchase arrangements can be cumbersome for businesses with several owners.
Entity-Purchase (Redemption) Agreement
The business itself buys back the departing owner’s interest, instead of the other owners doing so individually. The entity owns and pays for the insurance policies: one policy per owner, regardless of how many owners there are, which makes it dramatically simpler to administer as ownership grows.
Hybrid Agreement
As the name implies, this format combines both, often giving the business the first option to purchase, with individual owners stepping in as a backup if the entity can’t or doesn’t. This offers flexibility as the ownership structure evolves, which is valuable for businesses that expect to add or lose owners over time.
The structure you choose also impacts taxes. In a typical corporate cross-purchase, the surviving owners generally receive cost basis in the additional shares they purchase. In a redemption, the remaining shareholders likely would not receive that same direct basis increase because the entity is purchasing the deceased owner’s interest. Tax implications vary considerably by entity type, so the agreement structure should be reviewed with tax counsel before implementation.
Entity-funded agreements also warrant another tax consideration after the Supreme Court’s 2024 decision in Connelly v. United States. The Court held that life insurance proceeds received by a closely held corporation to fund a stock redemption increase the corporation’s fair market value for federal estate-tax purposes, while the redemption obligation itself does not necessarily offset that value. That could increase the estate-tax value of the deceased owner’s shares.
Setting the Purchase Price: Business Valuation Methods
There are several valuation methods you can use to set a fair purchase price.
Fixed price. Business owners agree on a specific dollar figure at signing, with the intention of revisiting it periodically. Simple in concept, but “periodically” can slip to “never” in a budding and busy enterprise. A fixed price set five years ago at a fraction of the company’s current value could create a windfall for one side and a raw deal for the other.
Formula-based valuation. That could be book value, a multiple of earnings, a multiple of revenue, or some other calculation. It’s objective and easy to administer, but the formula itself can significantly over- or undervalue the business depending on what it’s built around. A straight book value formula, for instance, could significantly understate a service business with few hard assets but substantial earning power.
Independent appraisal. A qualified third party determines fair market value at the time the trigger occurs. This can produce a more defensible current valuation, particularly when the agreement defines the standard of value, valuation date, appraiser qualifications, and process for resolving disagreements.
Right of first refusal. The business or remaining owners have the option to match any bona fide offer from an outside buyer before an owner can sell to a third party. Useful as a control measure, though it doesn’t establish price on its own, so it’s usually paired with one of the methods above.
Whichever method you choose, it needs a built-in system for keeping the valuation current. That could be an annual valuation update, a scheduled appraisal every two or three years, or a formula whose inputs are refreshed annually.
Note that simply putting a price in a buy-sell agreement does not guarantee the IRS will accept that number for estate-tax purposes. For certain agreements (particularly among family members), federal tax rules impose additional requirements before contractual restrictions or pricing will control valuation.
Funding the Buyout Agreement
A purchase price means nothing if there’s no money behind it if a trigger occurs.
Life Insurance
The cleanest and most common funding source for a death trigger. The death benefit can provide liquidity without driving the surviving owners to immediately sell business or personal assets to fund the purchase.
The policy needs to be owned by the correct party for the agreement’s structure (individually for a cross-purchase, by the entity for a redemption) since ownership affects both premium payment and how the death benefit is treated for tax purposes. Coverage amounts should be tied to the current valuation method and revisited on the same schedule as the valuation itself. It’s also worth confirming the policy’s beneficiary designation matches what the buy-sell agreement specifies; a mismatch between the two documents can lead to undue complications.
Disability insurance
Funds a buyout triggered by permanent disability — a scenario that can be inadvertently unfunded even if it’s named as a trigger in the agreement itself.
Disability buyout policies typically include an elimination period (e.g., 12 to 24 months) before benefits begin, which means the agreement needs its own provision for how the business bridges that gap. Definitions of disability also vary by policy, so it’s worth confirming the trigger language in your buy-sell agreement matches the definition used in the actual insurance policy funding it.
Installment Payments
Used when insurance isn’t available, isn’t sufficient, or the trigger is one that insurance doesn’t cover well — voluntary departure or retirement, for instance. The business pays the departing owner over time with interest.
This spreads the payment burden, which protects the business’s cash flow but does introduce ongoing risk: the business needs to remain financially healthy enough to make payments for years after the owner has left, and the departing owner is now effectively a creditor of a company they no longer control.
Agreements using this structure should include specific default provisions (what happens if a payment is missed) and often benefit from a security interest in business assets to protect the departing owner if things go sideways.
Sinking Fund
The business sets aside cash reserves over time, specifically earmarked to fund a future buyout. This calls for disciplined financial management and ties up capital that could otherwise be reinvested in growth, which is why it’s not necessarily ideal for growing companies, though it can work well for stable, mature businesses with predictable cash flow.
Protecting What You’ve Built
Naturally, a buy-sell agreement protects a business. But really, it’s there to protect and support the people who depend on it — your co-owners, your employees, and your family, all of whom are exposed to the consequences of a poor ownership transition.
Keep in mind, though, that a buy-sell agreement that isn’t coordinated with your personal estate plan, insurance coverage, and broader financial picture is solving only part of the problem. The strongest agreements are one piece of a comprehensive plan.
If you have an outdated buy-sell agreement (or you don’t have one at all), that’s worth addressing sooner rather than later.
I’m here if you need me.
