What Is a Buy-Sell Agreement, and How Is It Funded?
Buy-Sell Agreements
A buy-sell agreement is a contract between the owners of a business. It says what happens to an owner's share if they die, can't work, retire or want out: who buys it, at what price, and where the money comes from. Without one, your share could end up in a dispute, or with someone your co-owners never chose.
Why every business with more than one owner needs one
Picture two owners who built a business together. One dies unexpectedly. Their share passes to their spouse, who now owns half of a business they’ve never worked in. The surviving owner needs someone who can do the work, and the spouse needs income, not a stake in a company. Neither has the cash to make the other whole. Without a plan, the result is often a hurried sale or a dispute.
A buy-sell agreement settles this in advance. It’s a contract, signed while everyone is healthy and on good terms, that says what happens to an owner’s share if certain events happen. It’s often described as a prenuptial agreement for business owners. Even a business with one owner can benefit from a similar plan, for example an agreement with a key employee to buy the business.
What a good agreement covers
Most agreements answer four questions:
- What triggers a sale? Common triggers are death, a long-term disability, retirement, leaving the business, divorce and bankruptcy.
- Who buys? The other owners, the business itself, or sometimes a named key employee or family member.
- What’s the price? The agreement might set a fixed price that the owners update each year, a formula (such as a multiple of earnings), or a requirement for an independent appraisal at the time of sale. A fixed price that nobody updates is one of the most common problems we see.
- How is it paid for? This is the funding, and it’s where many agreements fall short.
Cross-purchase or entity redemption?
There are two common ways to set one up.
- Cross-purchase. The owners agree to buy each other’s shares. Each owner usually owns insurance on the others. It can give the buyers a better tax basis in the shares they buy, but it gets complicated with many owners, because the number of policies grows quickly.
- Entity redemption. The business agrees to buy back the share, and the business owns the insurance. It’s simpler to run with several owners. Since a 2024 Supreme Court decision, Connelly v. United States, life insurance the business owns to fund a buyback can raise the value of the business for estate tax purposes, which matters for larger estates.
Some businesses use a hybrid that gives the owners or the business the first option to buy. Which structure fits is a decision for your attorney and CPA, and we can show you how each one would be funded.
Why funding matters
An agreement that says your co-owner will buy your share for a fair price is only half a plan if your co-owner doesn’t have the money. Funding makes sure the cash is there when it’s needed:
- Life insurance pays out at death, the moment the buyout is triggered. It’s the most common way to fund the death part of an agreement.
- Disability buyout insurance pays a lump sum, or a series of payments, to buy out an owner who can’t work after a waiting period, often a year or more.
- Installment payments spread the price over several years. This depends on the business staying healthy without the departing owner.
- A sinking fund, money set aside in advance, works for planned events like retirement, but rarely builds fast enough for a sudden one.
Many agreements use insurance for the unexpected events and installments for planned ones, such as retirement.
Keep it current
A buy-sell agreement isn’t a one-time task. Review it every year or two, and whenever the value of the business changes, an owner joins or leaves, or the tax rules change. Check that the price, or the formula, still reflects what the business is worth, and that the insurance amounts still match the price.
Who does what
Your attorney drafts the agreement, and your CPA advises on the tax side and the valuation. We help you work out how much funding the agreement needs and coordinate the coverage that pays for it, and when you need a specialist, we bring one in from our network of trusted professionals. If something happened to you, your family would also need to know where this agreement is and who to call; What Would My Family Need to Know If Something Happened to Me? covers that.
Questions to ask about your agreement
- Do we have a signed agreement, and where is it?
- Does it cover disability and retirement, not just death?
- When was the price last updated, and does it still reflect what the business is worth?
- Is it funded, and do the insurance amounts still match the price?
- Is a cross-purchase or an entity-redemption structure better for us now?
The free Business Owner Blind Spot Check asks about this in about two minutes. When you’d like to talk it through, we’re glad to meet, at no cost and no obligation. See how we work with owners on Owning a Business.
Quick answers
- What is a buy-sell agreement?
- A contract between a business's owners that sets out what happens to an owner's share when certain events happen, such as death, disability, retirement or leaving the business. It says who buys the share, how the price is set and how the purchase is paid for.
- What's the difference between a cross-purchase and an entity-redemption agreement?
- In a cross-purchase agreement, the remaining owners buy the departing owner's share themselves. In an entity-redemption agreement, the business buys the share back. The choice affects taxes, who owns any insurance, and how the business is valued, so it's worth deciding with your attorney and CPA.
- How is a buy-sell agreement funded?
- Most often with life insurance for a death and disability buyout insurance for a disability, so the money is there the moment it's needed. Other options include paying in installments over several years or setting money aside in advance, but those depend on the business having the cash when the time comes.
- How often should a buy-sell agreement be reviewed?
- Every year or two, and whenever the business's value, the owners or the tax rules change. An agreement with a price set years ago, or insurance that no longer matches what the business is worth, can leave a family or co-owner short.