Could Your Business Benefit From a Buy-Sell Agreement?

How advance planning can protect the company, its owners, and their families when ownership changes

Many business owners have detailed plans for next quarter but no binding plan for the day an owner can no longer, or no longer wants to, remain in the business. Informal understandings may feel sufficient while everyone is healthy, productive, and getting along. They are far less reliable after a death, disability, divorce, dispute, or sudden departure.

A buy-sell agreement is a contract among the owners, and sometimes the business itself, that establishes the rules for a future ownership transition. It is not an agreement to sell the entire company today. It is a contingency plan that can restrict who may become an owner, identify events that trigger a purchase, establish a valuation process, designate the buyer, and provide a method for funding the transaction. Without one, ownership interests may pass to unintended parties, such as heirs unfamiliar with the business, former spouses, or creditors, creating management conflicts, valuation disputes, governance deadlock, and disruption to operations. Those risks can also derail carefully constructed estate plans and jeopardize the business's long-term viability.

Who Typically Considers a Buy-Sell Agreement

A buy-sell agreement tends to come up whenever the identity, participation, or continued ownership of a particular person matters to the business. That includes far more than companies already preparing for an owner's retirement.

• Any business with two or more owners. Even long-time partners can have different expectations about death, disability, retirement, compensation, or a voluntary exit.
• A 50/50-owned business. Equal ownership can become a governance deadlock unless the governing documents address decision-making and exit rights.
• A family-owned business. The plan can distinguish between family members who will work in and lead the company and those who should receive economic value without management authority.
• Spouses who jointly own a business. The agreement can coordinate with estate planning and marital agreements and address death, incapacity, and divorce.
• An owner who expects a child, key employee, or management team to become a future owner. The agreement can create a controlled path for a buy-in or phased transition.
• A business that depends heavily on one owner's relationships, licenses, guarantees, or technical knowledge. An ownership plan works best when coordinated with a management-continuity plan.
• A business with an existing agreement that has not been reviewed in years. An outdated formula, inadequate insurance, or a structure that no longer matches the tax classification can be worse than no plan, because it creates false confidence.

A sole owner may not need a traditional multi-owner buy-sell agreement, but still faces the underlying succession question. Depending on the circumstances, planning in that setting may involve an agreement with a key employee or outside buyer, a transfer plan for family members, insurance-funded liquidity, and clear authority for someone to operate or sell the business during incapacity or after death.

What Problems Can the Agreement Address?

Keeping unintended owners out

Without enforceable transfer restrictions, an ownership interest may pass to an estate, trust, former spouse, creditor, or family member who was never expected to participate in the company. A properly coordinated agreement can limit transfers, separate economic rights from voting or management rights, and give the company or other owners a purchase option or obligation.

Creating liquidity for the departing owner or family

Closely held business interests are usually illiquid. A buy-sell arrangement can create a market where none otherwise exists and can convert an ownership interest into cash or a secured payment stream. That liquidity may help a retiring owner, support a surviving family, pay estate taxes and expenses, settle debts, or equalize inheritances when only some children will receive the business.

Reducing valuation fights

The agreement can establish an appraisal process, a formula, a periodically agreed value, or a combination of methods. The objective is not merely to insert a number. The objective is to create a process that remains credible when the owners' interests are no longer aligned, and, if properly structured, one that can also hold up for federal estate and gift tax purposes.

Protecting management continuity

Ownership and control are related but not identical. A comprehensive plan addresses who may vote, manage, sign, serve on the board, access information, and receive distributions while a buyout is pending. This can prevent a transition from becoming an operational shutdown, and it allows the business to continue serving clients, retaining key employees, and maintaining relationships with lenders and suppliers.

Common Events the Agreement Should Address

Death is only one possible trigger. The agreement defines the events that matter to the particular business and specifies whether each event creates a mandatory purchase, an option, a right of first refusal, or another remedy. Common triggers include:

• death or a specified period of disability or incapacity;
• retirement or voluntary withdrawal;
• termination of employment, with different treatment for a departure with or without cause;
• divorce or a court-ordered transfer to a spouse;
• bankruptcy, creditor attachment, or an attempted prohibited transfer;
• loss of a required professional license;
• material breach of the operating, shareholder, partnership, or employment agreement; and
• deadlock among owners when a defined resolution process fails.

The same price and payment terms need not automatically apply to every trigger. Death may be funded by insurance and paid promptly, while a voluntary departure may involve installment payments to protect working capital. A punitive price for an owner accused of misconduct can also invite a separate fight over whether the trigger occurred. Precision matters.

Three Common Purchase Structures

1. Cross-purchase

The remaining owners purchase the departing owner's interest directly, and life insurance is often owned by the other owners to fund a purchase at death. The purchasing owners generally obtain tax basis equal to what they pay for the acquired interest, which can reduce capital gains tax on a later sale or on a transfer to the next generation. The structure works well with a small ownership group and a succession plan that envisions ownership consolidating among the remaining current owners. Its complications grow with the group: the number of life insurance policies increases rapidly as owners are added (four owners require twelve policies), and it is less suited to a plan that passes ownership to children or key employees who are not yet owners and parties to the agreement.

2. Entity redemption

The business itself purchases (redeems) the departing owner's interest. The insurance and funding structure is often simpler, because the company can own one policy on each insured owner, and administration is easier for larger ownership groups. The entity can also control who becomes an owner after the redemption. The trade-off is that the remaining owners generally do not receive an increase in the basis of their existing interests, which can mean higher capital gains tax on a future sale or succession transfer, and company-owned insurance can carry valuation consequences that deserve modeling before the structure is chosen. In S corporations, redemptions can affect shareholder basis in unexpected ways, particularly where the corporation carries debt.

3. Hybrid or “wait-and-see” arrangement

The agreement establishes an order of options: commonly, the company has the first opportunity to purchase, followed by the remaining owners, or vice versa. This preserves flexibility to consider available cash, tax basis, insurance, successor readiness, and other factors when the trigger occurs, and it can accommodate phased succession, with the entity redeeming part of an interest and co-owners or successors acquiring the remainder. The price of that flexibility is drafting complexity: the agreement must be especially clear about who decides, in what sequence, and by what deadline. Hybrid structures come up frequently in family businesses and in businesses where key employees are being groomed as successors.

Valuation: A Number Is Not a Plan

A fixed price that is never updated can become detached from reality. A formula based on revenue, earnings, book value, or another metric may also produce a distorted result after the business changes. A stronger agreement explains who performs the valuation, what standard of value applies, how discounts and debt are treated, the valuation date, how disagreements are resolved, and how often the method or agreed value is reviewed.

Federal estate and gift tax rules add another layer. Under Internal Revenue Code Section 2703, the price or restriction in a buy-sell agreement is not automatically respected for transfer-tax valuation. To qualify for the statutory exception, the arrangement must satisfy three requirements: it must be a bona fide business arrangement; it must not be a device to transfer property to family members for less than full and adequate consideration; and its terms must be comparable to similar arrangements entered into by unrelated parties at arm's length. In plain English: a family cannot simply write an artificially low price into an agreement and assume the IRS must accept it. Where the requirements are not met, the IRS may value the interest at fair market value without regard to the buy-sell restrictions, potentially producing a higher estate tax bill and undermining the plan.

An agreement is generally more likely to satisfy Section 2703 where more than 50 percent of the equity is owned by individuals who are not family members of the transferor and who are subject to the same restrictions; where the valuation formula is based on an objective standard, such as an independent appraisal or a formula tied to earnings or book value, and is updated regularly; and where the price or formula was negotiated at arm's length when the agreement was adopted. One caution worth knowing: a substantial modification of an existing agreement is treated as the creation of a new agreement and re-triggers Section 2703 scrutiny.

A related rule applies to lifetime transfers. Under Section 2512, a transfer of property for less than adequate and full consideration may be treated as a gift subject to gift tax. Where a buy-sell agreement permits or requires a below-market transfer, for example a discounted sale of interests to children or key employees, gift tax exposure can arise unless the pricing reflects fair market value or the arrangement fits within the recognized exceptions. Lifetime gifting strategies, including annual exclusion gifts, use of the lifetime exemption, and valuation discounts for minority interests and lack of marketability, interact with the agreement's pricing terms, so the two are commonly designed together rather than in isolation.

Funding: The Promise Must Be Payable

A mandatory buyout without a realistic funding plan can strain or even destabilize the company. Funding may come from life or disability insurance, accumulated cash, installment payments, borrowing, an earn-out, or a combination. The agreement can address not only the price but also interest, security, guarantees, prepayment rights, subordination to bank debt, and what happens if insurance proceeds are insufficient.

Life insurance is the most common funding vehicle, but ownership and beneficiary designations matter. Death benefits are generally income-tax-free to the recipient, yet transfers of existing policies can create federal transfer-for-value concerns that make proceeds partially taxable outside the safe harbors, and employer-owned policies carry separate notice, consent, and reporting requirements. In C corporations, premiums are not deductible, and proceeds increase the corporation's earnings and profits and can raise accumulated earnings tax concerns where a closely held corporation retains earnings without a business purpose. Policies, coverage amounts, and beneficiary designations are best reviewed with the agreement rather than purchased in isolation.

The Supreme Court's Connelly Decision: Why Structure Matters

In Connelly v. United States, decided in 2024, a corporation used company-owned life insurance to redeem a deceased shareholder's stock. The U.S. Supreme Court held that the corporation's contractual redemption obligation was not necessarily a liability that reduced the corporation's value for federal estate tax purposes. The insurance proceeds were therefore included when valuing the company, producing a substantially higher estate-tax value for the deceased owner's shares.

Connelly does not make entity redemptions unusable. It does mean that owners should not assume the redemption obligation will offset company-owned insurance dollar for dollar in the estate-tax valuation. Existing insurance-funded agreements are natural candidates for review, particularly where estate-tax exposure is possible or company value has increased materially.

Entity and Tax Classification Can Change the Answer

S corporations

S corporations may have only eligible shareholders and generally only one class of stock. A transfer to an ineligible person, such as a nonresident alien, a corporation, a partnership, or most trusts, or to a trust that is not properly structured or elected, can jeopardize the S election. Buy-sell agreements in this setting therefore restrict impermissible transfers and coordinate any grantor trust, qualified subchapter S trust (QSST), or electing small business trust (ESBT) planning, so that intended successors can actually hold the stock without terminating the election. Redemption treatment matters too: the redeeming shareholder may recognize gain where proceeds exceed basis, a redemption that does not qualify for sale-or-exchange treatment under Section 302 can be recharacterized with consequences for basis and loss limitations, and remaining shareholders receive no basis step-up. Where the corporation carries debt, redemptions can further complicate basis and the treatment of distributions, which is why these effects are typically modeled before the purchase structure is selected.

LLCs and partnerships taxed as partnerships

A direct purchase and an entity redemption can have different consequences for the exiting owner, the buyer, and the remaining owners. A Section 754 election may permit adjustments to the tax basis of partnership assets after certain transfers or distributions, providing remaining members benefits similar to a cross-purchase, though the election adds administrative complexity and is generally irrevocable. Section 751 can cause part of the gain to be taxed as ordinary income when the entity holds appreciated inventory, unrealized receivables, or other “hot assets,” an issue that can surprise both the exiting owner and the successors. The governing agreement also distinguishes a transfer of economic rights from admission as a voting or managing member: by default in many jurisdictions, a transferee receives only the transferor's economic rights unless admitted as a full member, which makes the buy-sell provisions the natural place to define when and how governance rights transfer. In partnerships, general and limited partner interests may warrant different buyout terms, and successors are sometimes admitted as limited partners first and elevated as they demonstrate readiness.

C corporations

Corporate and shareholder-level tax must be considered together, because C corporation income is taxed at the entity level and again on distributions. A redemption generally does not increase the remaining shareholders' basis in their existing stock, which raises future capital gains cost on a sale or succession transfer; cross-purchase structures funded with individually owned policies are one way that basis result is sometimes addressed. The company's use of insurance or accumulated cash can affect both valuation and future planning, and where a corporation later converts to S status or to an LLC taxed as a partnership as part of a succession plan, the lack of a basis step-up from a prior redemption can become expensive. Voting and non-voting stock classes, shareholders' agreements, and voting trusts are common tools for gradual succession, allowing a senior generation to transfer non-voting stock while retaining voting control.

The label on the entity is not enough. An LLC may be taxed as a partnership, S corporation, C corporation, or disregarded entity, and the tax classification can materially change the result.

When Spouses Jointly Own the Business

Spousal co-ownership adds its own layer. Upon divorce or death, a business interest may become subject to equitable distribution or estate administration, and buy-sell agreements in this setting commonly address whether the non-owner spouse has any rights in the event of divorce or the owner-spouse's death; whether the company or remaining owners have a right or obligation to purchase an interest held by, or awarded to, a non-owner spouse; how the interest is valued in a marital property division versus a buyout; and how the agreement interacts with any marital, premarital, or postnuptial agreements. Some agreements include a “divorce trigger” requiring the owner-spouse (or the entity or co-owners) to purchase an ex-spouse's awarded interest; others treat divorce as a general transfer subject to rights of first refusal. The succession question sits underneath all of it: whether a surviving spouse is intended to step into an active ownership and management role, receive economic rights only, or be bought out to provide liquidity and facilitate succession to children or other successors.

Coordinating the Agreement With the Estate Plan

A will or trust does not replace a buy-sell agreement, and it generally cannot give beneficiaries more rights than the owner possessed. The documents work best when designed together. Areas commonly reviewed side by side include:

• Wills and trusts: Who receives the ownership interest or sale proceeds, and can the trust legally hold the interest?
• Powers of attorney: Does an agent have sufficient authority to address ownership, voting, insurance, and a buyout during incapacity?
• Marital agreements and spousal rights: Are divorce, elective-share, community-property, or equitable-distribution issues addressed consistently?
• Insurance and beneficiary designations: Do policy ownership and beneficiaries match the party obligated to purchase?
• Leadership succession: Who runs the company while ownership is being valued and transferred?
• Inheritance equalization: If one child receives the business, what assets or insurance will provide value to children who do not?

For owners domiciled in Florida, one interaction deserves particular attention: the estate will be administered under Florida probate law even where the entity itself is governed by another state's law, so agreements that provide liquidity and clear instructions can help avoid probate delays and disputes. Florida's homestead and exempt property laws can also affect the distribution of an estate and the availability of assets to fund buyouts or equalize inheritances among heirs.

Why Jurisdiction Matters: Delaware Entities Operating in Florida

Consider a common arrangement: a business formed in Delaware but operating in Florida. Under the internal affairs doctrine, the law of the state of organization, here Delaware, governs the relationships among owners, the rights and duties of managers and directors, and the validity and enforcement of governance documents such as operating agreements, bylaws, and shareholders' agreements. A buy-sell agreement, to the extent it addresses ownership rights, transfer restrictions, governance, and internal disputes, is interpreted and enforced under that law.

Delaware is widely recognized for flexible, well-developed entity statutes, an extensive body of corporate and LLC case law, and a specialized Court of Chancery. Its courts generally enforce unambiguous buy-sell provisions, valuation formulas, and transfer restrictions, provided they are not unconscionable or contrary to public policy, and Delaware LLC law in particular affords broad freedom of contract: an operating agreement may modify default governance rules, impose transfer restrictions, and customize nearly every aspect of the LLC's internal affairs. Delaware also does not require member or shareholder lists to be filed publicly, which offers privacy but makes it important that the entity's internal records and the buy-sell agreement clearly document ownership and transfers.

Florida law can still apply to a great deal: qualification to transact business, employment and compensation arrangements with Florida-based employees, real and tangible property located in Florida, professional licensing, sales and employment taxes, and certain tort and statutory claims arising from Florida operations. A Delaware entity doing business in Florida must register with the Florida Department of State as a foreign entity, maintain a registered agent in Florida, and file annual reports and fees in both states to remain in good standing, which helps preserve limited liability and the enforceability of the governing documents. Where the business provides professional services, Florida's restrictions on ownership of professional entities by non-licensees directly affect who may be a permitted transferee under the buy-sell agreement.

This is one example of a broader planning point: a buy-sell agreement must account for both the entity's formation law and the laws that apply where the owners and business actually operate. The buy-sell agreement, operating agreement or bylaws, and state filings are best reviewed together, and a clear choice-of-law provision and dispute-resolution forum (courts or arbitration) reduce uncertainty. A choice-of-law clause is important, but it is not a magic eraser for every other applicable law. Transfer restrictions also carry their own formalities: in the corporate setting, restrictions are generally noted conspicuously on share certificates or in the information statement provided to shareholders to be enforceable against transferees without actual knowledge.

Practices Commonly Seen in Well-Maintained Agreements

Across entity types, certain themes recur in buy-sell arrangements that hold up over time. The succession vision comes first: who is intended to own and lead the business, on what timeline, and through what milestones. The structure follows from that vision together with the entity type, owner count, tax situation, and funding capacity, sometimes including phased approaches such as gifting non-voting interests to the next generation while retaining voting control. Valuation methods tend to be objective, regularly updated, and, where estate tax is a concern, designed with Section 2703 in mind, often supported by independent appraisal. Funding is modeled rather than assumed, with attention to whether insurance is individually or entity-owned and whether proceeds will also need to cover estate taxes or inheritance equalization. Every relevant trigger is defined, with the buyout process specified for each, including how disability interacts with the succession timeline. And because succession involves leadership, relationships, and institutional knowledge as much as ownership, the ownership plan is typically paired with successor development: training, mentoring, phased transfers of authority, advisory boards, and employment or consulting arrangements. In family businesses, the plans that age best also address fairness directly, planning how inheritances will be equalized and communicating the plan clearly to avoid surprises and resentment.

Questions That Often Frame the Drafting Discussion

• Who is allowed to become an owner, and who is not?
• Which events trigger a mandatory purchase, an option, or only a right of first refusal?
• Who buys first: the company, the other owners, a successor, or some combination?
• How will the interest be valued, and when was the valuation method last tested?
• How will the purchase be funded without starving the business of operating cash?
• What happens to voting, management, compensation, and distributions while the buyout is pending?
• Do the tax classification, insurance ownership, and estate plan support the intended result?
• How will disputes be resolved, and in what court or arbitration forum?
• When must the agreement, valuation, and insurance be reviewed again?

When Agreements Are Commonly Reviewed

Reviews typically follow any major change in ownership, business value, tax classification, family circumstances, insurance, debt, or succession goals, with periodic confirmation of the valuation and funding even without a major event and a more comprehensive legal and tax review at least every few years. Amendments carry one technical caution noted earlier: a substantial modification is treated for Section 2703 purposes as a new agreement.

Frequently Asked Questions

What is a buy-sell agreement? A buy-sell agreement is a contract among the owners of a business, and sometimes the business itself, that establishes the rules for a future ownership transition. It is not an agreement to sell the entire company today. It is a contingency plan that can restrict who may become an owner, identify events that trigger a purchase, establish a valuation process, designate the buyer, and provide a method for funding the transaction.

Who typically considers a buy-sell agreement? A buy-sell agreement tends to come up whenever the identity, participation, or continued ownership of a particular person matters to the business: any business with two or more owners, 50/50-owned businesses, family-owned businesses, spouses who jointly own a business, owners planning for a child or key employee to become a future owner, businesses that depend heavily on one owner, and businesses with an existing agreement that has not been reviewed in years.

What events typically trigger a buy-sell agreement? Common triggers include death, a specified period of disability or incapacity, retirement or voluntary withdrawal, termination of employment, divorce or a court-ordered transfer to a spouse, bankruptcy or creditor attachment, loss of a required professional license, material breach of the governing agreements, and deadlock among owners.

What are the three common buy-sell purchase structures? The cross-purchase, in which the remaining owners purchase the departing owner's interest directly; the entity redemption, in which the business itself purchases the interest; and the hybrid or wait-and-see arrangement, which establishes an order of options, commonly giving the company the first opportunity to purchase followed by the remaining owners. There is no universally best structure.

Does the IRS have to accept the price in a buy-sell agreement? No. Under Internal Revenue Code Section 2703, the price or restriction in a buy-sell agreement is not automatically respected for transfer-tax valuation. To qualify for the statutory exception, the arrangement must be a bona fide business arrangement, must not be a device to transfer property to family members for less than full and adequate consideration, and must contain terms comparable to similar arm's-length arrangements.

What did the Supreme Court decide in Connelly v. United States? In Connelly v. United States, decided in 2024, the U.S. Supreme Court held that a corporation's contractual obligation to redeem a deceased shareholder's stock was not necessarily a liability that reduced the corporation's value for federal estate tax purposes. The company-owned life insurance proceeds were therefore included when valuing the company, producing a substantially higher estate-tax value for the deceased owner's shares.

The Bottom Line

A well-designed buy-sell agreement does more than set a sale price. It protects ownership, creates liquidity, supports management continuity, coordinates with the estate plan, and reduces the chance that a predictable life event becomes a business emergency. The document must be tailored to the owners, entity, tax classification, funding, family circumstances, and succession objectives, and then kept current.

Selected Authorities and Further Reading

• U.S. Supreme Court, Connelly v. United States (2024)
• 26 U.S.C. Section 2703 - Certain rights and restrictions disregarded
• IRS overview of S corporation eligibility requirements
• IRS FAQs for the Section 754 election
• Delaware Limited Liability Company Act
• Florida Statutes Section 605.0902 - Foreign LLC certificate of authority
• Florida Statutes Section 607.1501 - Foreign corporation authority

This article is for general educational purposes only and is not legal, tax, accounting, insurance, or investment advice. The appropriate structure depends on the governing documents, applicable law, tax classification, ownership, family circumstances, and transaction terms. Reading this article does not create an attorney-client relationship.