Every business partnership begins with optimism. Two or more people come together with a shared vision, complementary skills, and mutual trust. What most don’t spend enough time thinking about is what happens when that partnership ends, not if, but when.
Ownership transitions are inevitable. Without a plan in place before they happen, the consequences can be severe for the business, the surviving partners, and the families of everyone involved.
A buy-sell agreement is that plan. Think of it as a business prenuptial agreement. A legally binding document that determines what happens to an owner’s share of the business if they die, become disabled, retire, or choose to leave. It establishes in advance who can buy that interest, at what price, and how the purchase will be funded.
What Triggers a Buy-Sell Agreement?
The most common triggering events are death, disability, retirement, divorce, bankruptcy, or a voluntary departure. Without an agreement in place, a deceased owner’s share could pass to heirs who have no experience running the business, giving them legal standing as co-owners regardless of their qualifications.
A buy-sell agreement prevents this by giving remaining owners the ability to purchase that interest at a predetermined or formula-based price, keeping control of the business where it belongs.
The Two Primary Structures
Cross-purchase agreements have the remaining owners purchase the departing owner’s interest directly. This can be advantageous for tax purposes, as the buyers receive a stepped-up cost basis in the acquired shares.
Entity-purchase agreement, also called redemption agreements, have the business itself buy back the departing owner’s interest. This is administratively simpler but carries an important tax consideration worth understanding.
In 2024, the U.S. Supreme Court’s decision in Connelly v. United States clarified that life insurance proceeds used to fund a redemption count toward the company’s value for federal estate tax purposes, potentially inflating the taxable value of a deceased owner’s interest.
For businesses with any value, this ruling is a strong reason to review how your agreement is structured and funded with both an attorney and a tax advisor.
How Buy-Sell Agreements Are Funded
A buy-sell agreement is only as useful as the funding behind it. The most common funding mechanism is life insurance. Policies are taken out on each owner’s life, with the proceeds used to purchase the deceased owner’s interest when the time comes. This provides immediate liquidity at exactly the moment it’s needed most, without forcing the business to liquidate assets or take on debt to complete the buyout.
Disability income insurance can serve a similar role for disability-triggered buyouts. Which are actually more common than death-triggered events. And often more financially disruptive because the disabled owner may still have ongoing personal financial needs.
The Cost of Not Having One
Without a buy-sell agreement, an ownership transition can result in protracted legal disputes, unwanted co-owners, forced business sales, or the collapse of a company that took years to build. Courts may be asked to determine value, which is expensive and unpredictable. Surviving partners may be left negotiating with grieving families under the worst possible circumstances.
The agreement is far easier to create before a triggering event than after. It also needs to be reviewed periodically, as the business grows and ownership interests change in value. The terms and funding levels should be updated to reflect current reality.
Where to Start
A buy-sell agreement requires input from legal, tax, and financial professionals working together. A qualified financial professional at Barnum Financial Group can help you understand the funding options, structure the insurance component, and coordinate with your attorney and tax advisor to make sure the agreement is complete, current, and properly funded.
