A buy-sell agreement is a legal contract between co-owners of a business that controls what happens when one owner exits — whether through retirement, death, disability, or a forced separation. It sets the purchase price, identifies who can buy, and specifies how the transaction is funded.
If you have a co-owner and no buy-sell agreement, this article explains what you’re exposed to.
What a Buy-Sell Agreement Does
A buy-sell agreement answers four questions before a triggering event occurs:
Who can buy? The agreement defines who has the right — or obligation — to purchase a departing owner’s interest. Options include the remaining co-owners, the business itself, or a combination. It can also restrict who cannot buy — preventing a co-owner’s spouse or heirs from becoming a new partner.
At what price? The agreement specifies how the purchase price is determined. This might be a fixed price, a formula (e.g., a multiple of EBITDA), or a third-party appraisal. Getting this right matters: a price set 10 years ago may bear no relationship to today’s business value.
On what terms? Lump sum or installment payments? How long does the buyer have to close? What happens if the buyer can’t fund the purchase?
How is it funded? For death buyouts, the agreement is typically funded with life insurance. The business or co-owners purchase policies on each other’s lives. When an owner dies, the insurance proceeds fund the buyout without requiring the surviving owner to take on debt or sell assets.
The Three Types of Buy-Sell Agreements
Cross-purchase agreement: Co-owners agree to buy each other’s interest directly. Each owner purchases a life insurance policy on the other. Works well for two-owner businesses. Gets complicated with more owners because each owner needs a policy on every other owner.
Redemption agreement: The business agrees to buy back a departing owner’s interest. The business purchases life insurance on each owner. Simpler with multiple owners, but there are tax implications that need to be reviewed with a CPA.
Hybrid agreement: Gives the business the first option to redeem, then gives the remaining owners the right to purchase if the business declines. Most flexible, but also most complex.
What Happens Without a Buy-Sell Agreement
Without a buy-sell agreement, your co-owner’s family may become your new business partner. When your co-owner dies, their estate inherits their business interest. That estate — and eventually the heirs — may have no interest in running the business, no knowledge of your industry, and every right to demand distributions, access to records, or a forced sale.
Your options at that point are limited: buy them out at whatever price they demand, find a third-party buyer, or wind down the business. None of these happen quickly, and all of them are expensive.
Even in retirement scenarios, the absence of a buy-sell agreement creates problems. If you want to retire and sell your interest, what price do you and your co-owner agree on? How is it funded? What if your co-owner can’t afford to buy you out? A buy-sell agreement addresses all of this before the emotion and urgency of the actual event.
A Buy-Sell Agreement Is Not the Same as an Operating Agreement
Many business owners assume their operating agreement handles these situations. It usually doesn’t — not completely. Operating agreements may address the mechanics of a membership transfer but rarely include a valuation formula, funding mechanism, or binding obligation to buy.
A buy-sell agreement is a separate contract, signed by all owners, that imposes binding obligations. Both documents need to be consistent with each other.
When to Review Your Existing Buy-Sell Agreement
If you have a buy-sell agreement, review it every three to five years. Common problems with older agreements:
- The fixed price was set years ago and no longer reflects business value
- The life insurance policies haven’t kept pace with business growth
- An owner’s situation has changed (health, estate plan, marital status) in a way that affects the agreement
- The agreement doesn’t align with the owners’ current revocable living trusts
The Buy-Sell Agreement Review page explains what a review covers and what to look for.
Next Steps
If you have co-owners and no buy-sell agreement, or if your existing agreement hasn’t been reviewed in more than three years, this is a gap in your business succession plan. Book a Family Protection Audit to talk through what you have and what you need.