Buy-Sell Agreements: Protecting Your Business When an Owner Exits

By Hank FasthoffJuly 5, 2026

Every multi-owner business will eventually face a departure. An owner dies, becomes disabled, retires, gets divorced, goes bankrupt, loses a professional license, or simply wants to leave. Without a buy-sell agreement, the remaining owners and the departing owner (or their heirs, their creditors, or their ex-spouse) are left to negotiate the terms of the buyout in real time, under pressure, with no agreed framework and no predetermined price. Those negotiations produce disputes, delays, and litigation that a properly drafted buy-sell agreement would have prevented.

A buy-sell agreement is a binding contract that establishes what happens to an owner's interest when a triggering event occurs. It specifies who can buy, who must sell, at what price, on what terms, and how the purchase will be funded. For LLCs, the buy-sell provisions are typically included in the company agreement (operating agreement). For corporations, they're typically in a standalone shareholders' agreement or stock purchase agreement. Either way, the agreement should be in place before any triggering event occurs, because negotiating buyout terms after the event is what produces the disputes the agreement was designed to prevent.

Triggering Events

A buy-sell agreement should define every circumstance that creates a purchase or sale obligation. Common triggering events include death, permanent disability, voluntary withdrawal or retirement, involuntary removal or termination for cause, bankruptcy or insolvency of an owner, divorce of an owner (where a court awards a portion of the business interest to a non-owner spouse), loss of a professional license (for businesses that require licensure), and felony conviction.

Each triggering event can produce a different set of rights and obligations. Death and disability typically create a mandatory buyout obligation, because the owner can no longer participate in the business. Voluntary withdrawal might trigger a right of first refusal rather than a mandatory buyout, giving the remaining owners the option to purchase but not the obligation. Involuntary removal for cause might include a discounted purchase price as a penalty.

Don't limit your triggering events to death and disability. Divorce is one of the most common and most disruptive events for closely held businesses, because a court can award a portion of a spouse's business interest to the other spouse in the property division. Without a buy-sell agreement that addresses divorce, the business may end up with an unwanted co-owner who has no relationship with the company, no operational role, and no obligation to cooperate with the remaining owners.

Agreement Structures

Buy-sell agreements follow one of three structures, and the choice between them affects taxation, funding, and complexity.

In a cross-purchase agreement, the remaining owners personally buy the departing owner's interest. Each purchasing owner acquires a proportionate share and takes a cost basis equal to the price paid, which reduces capital gains exposure on any future sale of the business. Cross-purchase agreements work well for businesses with two or three owners, because each owner needs a life insurance policy on each other owner's life to fund the buyout. With more than three or four owners, the number of required policies (the formula is n × (n-1), where n is the number of owners) becomes unwieldy. A three-owner business needs six policies. A five-owner business needs 20.

In an entity redemption agreement (also called a stock redemption for corporations), the company itself buys the departing owner's interest. The company owns life insurance policies on each owner's life and uses the death benefit proceeds to fund the buyout. Entity redemption is simpler to administer than cross-purchase, because only one policy per owner is needed, but it produces a less favorable tax result for the remaining owners, who don't receive a step-up in basis on their existing interests.

In a hybrid (or wait-and-see) agreement, the company has the first option to redeem the departing owner's interest, and if it declines (in whole or in part), the remaining owners have the right to purchase the balance through a cross-purchase. Hybrid agreements give the parties flexibility to choose the most tax-efficient structure based on the circumstances at the time of the triggering event.

Connelly v. United States Changed the Calculus for Entity Redemption

In Connelly v. United States, 144 S. Ct. 1406 (2024), the Supreme Court ruled that the value of corporate-owned life insurance used to fund a redemption obligation under a buy-sell agreement must be included in the value of the deceased owner's business interest for federal estate tax purposes. The Court held that the corporation's obligation to redeem the deceased owner's shares didn't offset the insurance proceeds for valuation purposes.

Before Connelly, many business owners assumed that corporate-owned life insurance used to fund a buy-sell redemption would increase the company's value for estate tax purposes but that the offsetting redemption obligation would reduce it back down. The Supreme Court rejected that logic. The result is that for businesses subject to the federal estate tax (estates exceeding the $13.99 million unified exemption for 2025), entity redemption funded by corporate-owned life insurance may produce a higher estate tax bill than a cross-purchase funded by individually owned policies.

After Connelly, every business owner with an entity redemption buy-sell agreement funded by corporate-owned life insurance should review the structure with counsel and a CPA to evaluate whether a cross-purchase or hybrid structure would produce a better estate tax result. For businesses well below the estate tax threshold, the Connelly decision may not change the analysis. For businesses whose owners' estates approach or exceed the exemption, it can be significant.

Valuation Methods

Buyout price is the provision that produces the most disputes, because it determines how much money changes hands. Buy-sell agreements use one of several valuation methods, and the choice should be made at the time the agreement is drafted, not at the time of the triggering event.

Fixed price (or agreed value) sets a specific dollar value for the business or for each owner's interest, updated periodically (typically annually) by agreement of all owners. Fixed price is simple, but it fails when the owners stop updating it, which they almost always do. A fixed value set three years ago may bear no relationship to the company's current worth, and a departing owner (or their estate) will challenge a stale valuation.

Formula-based pricing calculates the buyout price using a predetermined formula, typically a multiple of earnings (EBITDA, net income, or revenue) or book value. Formula pricing updates automatically with the company's financial performance, so it doesn't go stale. But the formula must be chosen carefully, because a multiple that produces a fair result at one stage of the company's growth may produce an unfair result at another.

Independent appraisal requires the parties to obtain a professional business valuation at the time of the triggering event. Appraisal is the most accurate method, because it reflects the company's actual value at the time of the buyout. It's also the most expensive and the slowest, because hiring an appraiser and completing the valuation takes time. Some agreements designate a specific appraiser or appraisal firm in advance; others establish a process for selecting one (each side picks an appraiser, and the two appraisers select a third who determines the final value).

Whatever method you choose, specify it in the agreement. An agreement that sets the buyout price at "fair market value" without specifying how that value is determined leaves the methodology open to dispute at the worst possible time.

Funding the Buyout

A buy-sell agreement is only as good as its funding mechanism. An agreement that requires the remaining owners to pay $2 million for a deceased owner's interest doesn't accomplish much if nobody has $2 million available.

Life insurance is the most common funding mechanism for death-triggered buyouts because it provides immediate liquidity at the moment of the event. In a cross-purchase structure, each owner holds a life insurance policy on each other owner's life. In an entity redemption structure, the company holds a policy on each owner's life. When the triggering event occurs (death), the insurance proceeds fund the buyout without requiring the business to generate the cash from operations or borrow.

Disability insurance provides analogous funding for disability-triggered buyouts, though disability buy-sell policies are less common and more expensive than life insurance.

Installment payments fund the buyout over time rather than in a lump sum. An agreement might provide that the departing owner receives 20 percent at closing and the balance over five years, with interest. Installment payments are common for voluntary withdrawal and retirement, where the departure is planned rather than sudden.

Sinking fund provisions require the company to set aside funds periodically in a reserve account designated for future buyout obligations. A sinking fund supplements insurance and installment payments but rarely covers the full buyout on its own.

In practice, most buy-sell agreements use a combination. Life insurance covers death. Disability insurance or installment payments cover disability. Installment payments cover voluntary withdrawal and retirement. The company agreement should specify the funding mechanism for each triggering event.

Restrictions on Transfer

A buy-sell agreement should restrict owners from transferring their interests without the consent of the remaining owners or the company. Common restrictions include a right of first refusal (before selling to a third party, the departing owner must offer the interest to the remaining owners or the company on the same terms), a right of first offer (the departing owner must offer to sell to the remaining owners before seeking outside buyers), and outright prohibitions on transfer without unanimous or majority consent.

Transfer restrictions prevent an owner from selling their interest to a competitor, an outsider the remaining owners don't want as a co-owner, or a third party who would change the dynamics of the business. Without transfer restrictions, any owner can sell their interest to anyone at any time, and the remaining owners have no recourse.

Practical Recommendations

Draft the buy-sell agreement at formation, before any triggering event occurs or is anticipated. Negotiating buyout terms between co-owners who are starting a business together and expect to work together for years is dramatically easier than negotiating between a remaining owner and a departing owner's estate or divorce attorney.

Cover every plausible triggering event. Death and disability are the minimum. Voluntary withdrawal, involuntary removal, bankruptcy, divorce, loss of licensure, and felony conviction should all be addressed, with the appropriate buyout mechanics specified for each.

Choose a valuation method and commit to it. If you use fixed pricing, schedule annual updates and treat them as mandatory. If you use formula pricing, test the formula against your financial statements to confirm it produces a reasonable result. If you use appraisal, designate the appraiser or the selection process in advance.

Fund the agreement. Buy life insurance on each owner's life in an amount sufficient to cover the buyout price. After Connelly, evaluate whether the policies should be owned by the individual owners (cross-purchase) or by the company (entity redemption), and structure accordingly.

Review the agreement every two years and after any significant change in ownership, valuation, or capital structure. A buy-sell agreement that reflected the business accurately five years ago may not reflect it today. Outdated agreements produce the same disputes as no agreement at all.