How Buy-Sell Agreements Work: A Guide for Business Owners

Sean McCulloch | Oct 16, 2026

What a Buy-Sell Agreement is Meant to Do

Without an agreement, an owner's death or departure can leave a business in an uncertain position. Ownership may pass to a spouse or heirs who have no role in the company, or to someone the remaining owners wouldn't have chosen. Meanwhile, the family of the departing owner may be left holding an illiquid asset they can't easily sell.

A buy-sell agreement may be designed to serve a few objectives, though it does not necessarily ensure any particular outcome:

Support business continuity. An agreement can establish how ownership may transition following a triggering event.
Establish an exit process. Valuation and payment provisions can provide a framework for determining the purchase price and payment terms.
Provide greater clarity. Documenting the intended ownership-transition process may help owners and other interested parties understand how certain events are expected to be handled.

The "Trigger Events" That Start a Buyout

Most agreements spell out which events set the buyout in motion. Common triggers include:

Death of an owner
Permanent disability (and how "disability" is defined, which varies a great deal from contract to contract)
Retirement
Voluntary departure or resignation
Termination of an owner who is also an employee
Divorce, which may put an ownership interest in play in a property settlement
Bankruptcy or creditor claims against an owner
A desire to sell to an outside party

Some of these are easy to define. Others, like disability or "for cause" termination, are where agreements most often turn out to be vague. It's worth reading your own agreement with these scenarios in mind.

The Three Main Structures

Cross-Purchase Agreement

Each owner agrees to buy a departing owner's share personally. With life insurance as the funding source, each owner typically owns a policy on the other owners.

Points owners often weigh:

The purchase may have tax-basis implications for the surviving owners, which should be reviewed with a qualified tax professional.
Insurance proceeds are paid to the surviving owners rather than the company, which may be relevant to estate tax valuation (see the Connelly section below).
The number of policies can grow quickly as owners are added. Three owners means six policies if each insures the others.
Premium costs may be uneven when owners differ in age or health.

Entity Redemption (Stock Redemption) Agreement

The company itself agrees to buy the departing owner's interest. The company owns the insurance, pays the premiums, and receives the proceeds.

Points owners often weigh:

Administration is simpler, since the company holds one policy per owner rather than a web of cross-owned policies.
The company's cash flow bears the premium cost, which affects all owners proportionally.
Because the company holds the policy proceeds, the structure received renewed attention after Connelly.
Tax treatment differs by entity type (C corporation, S corporation, LLC, partnership), so the entity form and the structure should be considered together.

Hybrid or "Wait-and-See" Agreement

The agreement gives the company, the remaining owners, or both a sequence of options at the time of the triggering event. Some owners choose this for flexibility. The tradeoff is that the funding and tax picture is less certain until the buyout actually happens, and the flexibility can complicate the planning in the meantime.

None of these is universally better. Which structure fits tends to depend on the number of owners, the entity type, the owners' relative ages and health, family circumstances, and the tax picture. That's why some owners with similar-looking businesses end up with very different agreements.

How the Price Gets Set

How the business interest will be valued is an important component of a buy-sell agreement. Common approaches include:

A fixed price stated in the agreement, updated periodically by the owners. Simple, but it can become stale quickly if the business grows or shrinks and nobody updates it.
A formula, such as a multiple of earnings or revenue. Predictable, but a formula that made sense when it was written may not reflect the business later.
An independent appraisal at the time of the event. More likely to reflect current value, though it adds cost and can involve disputes about who selects the appraiser and what methodology applies.
A hybrid, such as an agreed price that is reset annually, with an appraisal as the fallback if the owners haven't updated it.

A few questions worth asking about your own agreement: When was the price or formula last updated? Does it distinguish between a sale at death and a sale at retirement or termination? Does it address discounts for minority interests or lack of marketability? An agreement that is silent on these points leaves room for disagreement at the worst possible moment.

How the Buyout Gets Funded

A price on paper only works if there is a way to pay it. Owners commonly look at some combination of:

Life insurance on each owner, owned according to the structure chosen. Life insurance is one funding method owners may consider for a death-related triggering event. Availability and payment of benefits are subject to the terms and conditions of the applicable policy.
Disability buyout insurance, which is designed to fund a purchase if an owner becomes disabled under the policy's definition. These policies often carry waiting periods and definitions that may not match the agreement's definition, so the two are worth comparing side by side.
Installment payments (a promissory note) from the buyers to the departing owner or their family, which spreads the cost over time but introduces credit risk and a long-term relationship with the buyer.
Company cash reserves or a sinking fund, which keep funding in-house but tie up capital.
Borrowing, which may be an option but depends on credit availability at the time.

Funding gaps are among the most common issues owners find when they review an agreement. The business may be worth considerably more than it was when the insurance was purchased, so coverage that matched the price years ago may fall well short today. Underfunded agreements can force payment terms that neither side anticipated.

Why Connelly v. United States Matters

In June 2024, the U.S. Supreme Court decided Connelly v. United States, a case involving a closely held corporation that owned life insurance on a shareholder to fund a stock redemption. The Court held that, for federal estate tax valuation, the life insurance proceeds the company received were part of the company's value, and the company's contractual obligation to redeem the shares did not offset them.

In practical terms, the decision means that for entity redemption structures funded by company-owned life insurance, the insurance proceeds may increase the value of the deceased owner's stake for estate tax purposes. The case also reinforced that a price written into a buy-sell agreement does not automatically control the value the IRS uses for estate tax purposes. Whether an agreement's price is respected depends on meeting specific requirements.

Whether this affects any particular owner depends on things like the size of the estate relative to current estate tax thresholds, whether the state imposes its own estate or inheritance tax, the entity type, and how the existing agreement is structured. Some owners reviewing their agreements have looked at cross-purchase structures, at adjusting insurance amounts, or at other approaches. Each carries its own tradeoffs, including potential income tax issues when existing policies are transferred. These are questions for an estate planning attorney and tax professional to evaluate with you.

Common Issues That Surface in Agreement Reviews

When owners dust off an existing agreement, these are some of the items that frequently come up:

The agreement hasn't been reviewed in years, and the business, the owners, or the tax law has changed.
The price is outdated or the formula no longer reflects how the business creates value.
Funding doesn't match the price. Insurance amounts, if any, may be well below the current value.
Disability is defined differently in the agreement and in the insurance policy.
Spouses and heirs aren't aligned. An owner's family may not know the agreement exists or what it requires of them.
The agreement doesn't address divorce, bankruptcy, or an outside offer.
The agreement hasn't kept pace with the owners' broader planning, including wills, trusts, and beneficiary designations that may conflict with it.

Questions to Bring to Your Next Planning Conversation

Rather than a checklist of things to do, consider this a list of questions worth being able to answer:

Do we have a signed, current buy-sell agreement, and when was it last reviewed by an attorney?
Which structure does it use, and was that chosen with our current entity type and tax situation in mind?
How is the price determined, and when was it last updated?
Is there a funding plan, and does the funding level reasonably match the current price?
How does the agreement define disability, and does our disability coverage, if any, use the same definition?
Have we considered how the agreement interacts with our estate plans and, if relevant, our succession and exit plans?
Has anyone looked at the agreement since Connelly?

A buy-sell agreement touches legal, tax, insurance, and valuation questions all at once. That's why it typically works best as a coordinated conversation among the owners, their attorney, their CPA or tax professional, and their financial and insurance professionals, with each contributing within their own area.

How Buy-Sell Agreements Work: A Guide for Business Owners