Business Planning Guide
Buy-Sell Agreements: How They Work, Cross-Purchase vs Entity Redemption, and Funding with Life Insurance
A buy-sell agreement is a legally binding contract among business co-owners. It sets out who can or must buy an owner's interest, at what price, and how the purchase is paid for when a triggering event happens, such as death, disability, retirement, or divorce. Many owners fund the purchase with life and disability insurance.
Think of the agreement as a fixed point you agree on now, while everyone is healthy and on good terms, so that partners, families, and employees have a clear reference when circumstances change.
Schedule a ConsultationHow It Works
What a Buy-Sell Agreement Does
A buy-sell agreement answers three questions before anyone needs the answers: who buys, at what price, and with what money. If the agreement is silent or out of date, a departing owner's shares could pass to a spouse, an heir, or a creditor who has no role in running the company. The remaining owners may also have to negotiate a price under pressure.
A well-drafted agreement is designed to give the exiting owner or their family a defined path to liquidity, and to give the continuing owners a defined path to control. It cannot remove every dispute or tax consequence, and its usefulness depends on how carefully it is drafted, funded, and kept current.
Who drafts it: the agreement itself is a legal document drafted by the owners' attorney. The Stellarix Group does not draft legal documents or give tax or legal advice. Our role is the funding and planning side: insurance analysis, coordination with each owner's personal plan, and working alongside your attorney and CPA. You can see how this fits a broader exit strategy in our business succession planning guide.
Core Components of Most Agreements
- 1Structure: who has the right or obligation to buy (co-owners, the business, or a mix).
- 2Triggering events: the circumstances that start a buyout.
- 3Valuation: how the price is set and how often it is updated.
- 4Funding: insurance, cash reserves, installment notes, or a combination.
- 5Payment terms: lump sum or installments, interest, and security for any note.
Compare Structures
Cross-Purchase vs Entity Redemption vs Hybrid
The three common types of buy-sell agreements differ mainly in who buys the departing owner's interest. That choice affects how many policies you need, how the surviving owners' tax basis works, and how complex ownership becomes. The tax points below are general; results depend on entity type and facts, so your CPA and attorney should confirm them for your business.
| Factor | Cross-Purchase | Entity Redemption (Stock Redemption) | Hybrid / Wait-and-See |
|---|---|---|---|
| Who buys | The remaining owners personally | The business itself | Decided at the trigger. Often the business gets first option, then the owners, then the business must buy any remainder. |
| Number of life policies | Each owner insures every other owner: n x (n - 1) policies. With 4 owners, that is 12. | One per owner: 4 owners means 4 policies | Varies. Often owner-held policies so either buyer can be funded. |
| Surviving owners' basis | Buyers generally take a cost basis equal to the price they pay for the shares they acquire, which may lower gain on a later sale. | For C corporations, surviving owners' percentage rises but their basis generally does not. S corporations and LLCs can differ. | Depends on who ultimately buys |
| Deceased owner's estate | In either structure, inherited shares generally receive a basis equal to fair market value at death under 26 U.S.C. §1014 (current through P.L. 119-120, Oct. 7, 2026), subject to statutory exceptions. | ||
| Ownership complexity | Higher with many owners. Unequal ages or stakes can make premiums uneven. Some owners use a trustee or escrow arrangement, which adds its own legal review. | Simpler administration. Policies and cash value sit on the company's books and may be reachable by business creditors. | Most flexible, and the most dependent on careful drafting |
| Estate valuation after Connelly | Proceeds are paid to the owners, not the company, so they generally are not part of the company's value | Company-owned proceeds may increase the company's value for estate tax purposes (see below) | Depends on who owns the policies |
Policy counts are simple arithmetic for illustration. They are not a recommendation of any structure.
The Case That Changed the Math
Connelly v. United States and Entity-Owned Policies
June 6, 2024
Supreme Court decision date
No. 23-146
Docket number
Not offset
Redemption obligation vs. insurance proceeds
In Connelly v. United States (decided June 6, 2024), the Court held that, on those facts, life insurance proceeds paid to a corporation increased its fair market value for federal estate tax purposes. The corporation's contractual obligation to redeem the deceased owner's shares did not offset those proceeds. The Court also explained that a redemption obligation is not necessarily a liability that reduces company value. It did not say one never can.
In practice, owners with entity-redemption agreements funded by company-owned insurance may want their attorney and CPA to review their structure, particularly if an owner's estate could be large enough to face federal estate tax. Our 2026 estate tax exemption guide covers the current threshold. Changing structures can raise other issues, such as new underwriting or transfer-for-value concerns, so any change is worth modeling first.
When It Activates
Triggering Events to Define in Writing
Triggering events are the circumstances that start the buyout. Each one may call for a different price, payment schedule, and funding source, so the agreement should treat each separately.
Death
The trigger most often funded with life insurance. It is meant to give the family cash for the shares and keep ownership with the continuing owners.
Disability
The agreement's definition of disability and its waiting period should match any disability buy-out policy. If they don't, the policy may not pay when the agreement requires a purchase.
Retirement or Departure
Usually paid from cash flow or installment notes rather than a death benefit. Some agreements set different prices for voluntary and involuntary exits.
Divorce
Lets the owners or the company buy back shares awarded to a former spouse. How this works depends on state property law, so it calls for attorney guidance.
Termination or Loss of License
Common in professional practices where only licensed owners can hold equity.
Bankruptcy or Third-Party Offer
Rights of first refusal and transfer restrictions are meant to keep shares out of outside hands.
Setting the Price
Valuation Methods and Why They Drift
The valuation clause is often the weakest part of a buy-sell agreement. A price that was fair when the agreement was signed can drift far from reality, and insurance amounts tied to that price may no longer match what the buyer owes.
The Connelly opinion also shows this risk: the owners had not followed the agreement's own valuation process as written. A regular review schedule, often yearly, is one practical safeguard.
Fixed or Agreed Price
Simple, but only reliable if the owners update and sign a new certificate of value on schedule.
Formula
A multiple of earnings, revenue, or book value. Easy to apply, though it may not reflect intangible value or changing conditions in your industry.
Independent Appraisal
A qualified appraiser values the business at the trigger. Often considered more defensible, but it costs more and takes longer. The agreement should spell out the standard of value and any discounts.
Funding the Promise
Funding a Buy-Sell Agreement with Life and Disability Insurance
A buy-sell agreement promises a purchase; insurance is one way to pay for it. Life insurance is designed to provide cash at the moment the buyer needs it, and disability buy-out coverage can play a similar role if an owner can no longer work. Insurance also has costs and limits that deserve the same attention as the agreement itself. Our life insurance guide covers policy types in more depth.
Underwriting Is Not Guaranteed
Health, age, and avocations can raise premiums or lead to a decline. An owner who cannot be insured may need a different funding plan, such as a sinking fund or installment note.
Premium Cost and Fairness
In a cross-purchase plan, a younger owner may pay much more to insure an older partner. Owners sometimes adjust compensation to even out the burden, which has its own tax implications for your CPA to review.
Ownership and Beneficiary Pitfalls
The policy owner, the beneficiary, and the buyer named in the agreement should line up. A mismatch, such as a spouse named as beneficiary on a policy meant to fund a purchase, can send proceeds to the wrong person.
Transfer-for-Value Rule
Moving existing policies between owners or out of a company can cause part of the death benefit to become taxable under 26 U.S.C. §101(a)(2). Exceptions exist, including transfers to a partner of the insured or a partnership in which the insured is a partner. Get tax advice before restructuring.
Employer-Owned Policy Notice and Consent
For company-owned coverage, §101(j) generally requires written notice to and consent from the insured before the policy is issued, or the tax-free death benefit may be limited. Companies generally report these policies on IRS Form 8925. The same notice-and-consent rules generally apply to key person insurance.
Signed your agreement before mid-2024?
We can compare your funding against your current valuation and the Connelly decision, then share findings with your attorney and CPA.
Our Role
How We Coordinate with Your Attorney and CPA
A buy-sell agreement involves several advisors: the attorney drafts it, the CPA weighs the tax effects, and the insurance and planning team helps connect it to each owner's broader plan. The Stellarix Group's team includes professionals with the CLU, ChFC, CLTC, and CFP® designations. We focus on the funding and planning side, as part of our risk management and insurance planning and our work as a financial advisor for business owners.
Insurance and advisory services are offered through MML Investors Services, LLC, a MassMutual affiliate. We may be compensated through insurance sales. Ask us how we are paid on any recommendation, and we will explain it and any related conflicts in plain terms.
Some owners hold personal coverage in an irrevocable life insurance trust for estate planning reasons. Policies that fund a buy-sell agreement usually need a different owner and beneficiary arrangement, so the two should be planned together.
Buy-Sell Review Checklist
Request a Buy-Sell Funding Review
A conversation with our insurance and planning team about how your agreement is funded. We coordinate any findings with your attorney and CPA.
Common Questions
Buy-Sell Agreement FAQ
Why Do I Need a Buy-Sell Agreement?
You need one so that, if an owner dies, becomes disabled, retires, or divorces, there is already a plan for who buys their interest, at what price, and with what funds. Without one, shares could pass to heirs or ex-spouses, and the price may have to be negotiated under strain.
What Are the Types of Buy-Sell Agreements?
The three main types are cross-purchase (the owners buy), entity redemption or stock redemption (the business buys), and hybrid or wait-and-see (the buyer is chosen when the trigger happens). Each handles policy count, tax basis, and complexity differently.
Who Is the Beneficiary of Buy-Sell Life Insurance?
The beneficiary is usually whoever is obligated to buy. In a cross-purchase plan, that is the co-owner who owns the policy. In an entity redemption plan, it is the business. Naming a family member instead can leave the buyer without funds, so ownership and beneficiary designations should match the agreement.
What Are the Disadvantages of a Buy-Sell Agreement?
The main disadvantages are cost and upkeep. There are legal fees, ongoing premiums, and periodic valuations. A price that is never updated can be unfair to one side. Some owners can't get insurance. Entity-owned policies may now raise estate valuation after Connelly. And the agreement restricts each owner's freedom to sell to outsiders.
Can You Get Out of a Buy-Sell Agreement?
Usually, yes, if all parties agree in writing to amend or end it, or if the agreement includes its own termination terms. One owner generally cannot walk away alone. Changes are handled by your attorney, and the insurance funding should be reviewed at the same time.
Keep reading
Melissa Lang, CLU, ChSNC, CLTC and Tom Mueller, ChFC · Financial Advisors, The Stellarix Group
One Star to Guide the Way
Put Your Buy-Sell Agreement in Clear View
Whether you are drafting your first buy-sell agreement or revisiting one that hasn't been reviewed in years, our Denver-based team can help you look at structure, valuation, and funding together. We work with business owners in all 50 states and coordinate with your attorney and CPA.
2000 S Colorado Blvd, Tower 2, Ste 800, Denver, CO 80222