Protecting Your Business with a Well-Funded Buy-Sell Agreement

When a business has multiple owners, having different perspectives and skill sets can be a major strength. But what happens if one owner suddenly leaves, retires, becomes disabled, or passes away? Without a clear contingency plan, the business could face uncertainty, conflict, and even financial instability.

A buy-sell agreement addresses this issue but requires capital to make it work.

What a Buy-Sell Agreement Does

A buy-sell agreement is a legally binding contract among business owners that explains what happens when an owner exits the company. It gives the remaining owners, or the business itself, the right to buy out the departing owner’s interest after a “triggering event.”

Triggering events include:

• Death or disability

• Retirement or voluntary departure

• Divorce or personal financial trouble

• Loss of a professional license or certification

This agreement spells out the methods for valuing and transferring ownership interests to ensure a clear process for both remaining and departing owners or their families.

The Importance of Funding

When a triggering event occurs, buying out an owner’s share can require a substantial amount of cash. That’s why funding the buy-sell agreement is just as important as drafting it.

A popular solution is life insurance. While it’s most commonly used to provide funds when an owner dies, it can also be structured to support other triggering events. When structured correctly, the right policy can:

• Provide quick liquidity for buyouts

• Ease pressure on the company’s cash flow

• Prevent the need to sell business assets to raise funds

Using Life Insurance as a Buy-Sell Agreement

There are several ways to structure a buy-sell agreement using life insurance:

1. Cross-Purchase Agreement

Each owner buys a life insurance policy on the other owners.

• If one owner dies, the others receive the policy’s death benefit and use it to buy the deceased owner’s interest.

• The proceeds are generally income tax–free, and the purchasing owner receives a step-up in basis equal to the purchase price.

This arrangement may present additional complexity with multiple owners, since each owner requires an individual policy. Costs may also vary based on differences in age or health among the owners.

2. Trust or Partnership-Owned Policies

Instead of each owner buying separate policies, a trust or partnership can own one policy for each owner. When an owner dies, the entity collects the death benefit and distributes the funds for the buyout. This is a simpler way to ensure financial stability in the event an owner experiences a triggering event. The administration workload for this option is less for multi-owner businesses like s-corps and partnerships.

3. Redemption Agreement

In this version, the business itself owns and pays for the life insurance policies on each owner. When a triggering event occurs, the company receives the insurance proceeds and buys back the departing owner’s interest.

Here’s the downside – the remaining owners don’t receive a step-up in basis for their shares, potentially leading to higher capital gains taxes later.

Additionally, in the 2024 Supreme Court case Connelly v. United States, the Court ruled that the value of corporate-owned life insurance must be included in the deceased owner’s business interest for estate tax purposes, even without reducing that value for the company’s obligation to redeem the shares. This could increase the taxable value of the estate for businesses subject to federal estate tax.

(For reference, the federal estate and gift tax exemption is $13.99 million for 2025 and $15 million for 2026.)

The Takeaway

A buy-sell agreement is only as strong as its funding. Without the right plan in place, even the best-written agreement can fail to protect your business and its owners.

Work closely with your attorney to ensure your buy-sell is up-to-date and legally sound. Our team can advise you on the tax and estate planning implications of your choice.