A buy-sell agreement is the document that keeps a business from falling apart when an owner exits unexpectedly. It names the buyer, sets the price, and defines what counts as a triggering event.
Almost every guide on this topic treats the buy-sell as a legal question. Draft it correctly, sign it, file it away. That framing misses the part that actually determines whether the agreement works: the money has to exist on the day it is triggered.
A 2024 Supreme Court decision made that funding question considerably more complicated, and most owners have not heard about it yet.
What Is a Buy-Sell Agreement
A buy-sell agreement is a binding contract among co-owners that governs the transfer of an ownership interest when a specified event occurs. Partnerships, LLCs, and closely held corporations all use them.
Every agreement has to settle four things:
- Triggering events. Death and disability are standard. Retirement, divorce, bankruptcy, and voluntary departure are common additions, and each carries different consequences.
- Who has the right or obligation to buy. The remaining owners, the company itself, or a combination.
- How the interest gets valued. A fixed price, a formula, or an independent appraisal at the time of the event.
- How the purchase gets paid for. Cash, installments, borrowed funds, or life insurance proceeds.
Without one, a departing owner’s interest can pass to a spouse, an heir, or a creditor. The surviving owners can find themselves in business with someone who has no interest in running a company and every interest in being bought out.
Signed Is Not the Same as Funded
An agreement that obligates the surviving owners to buy a departed owner’s interest is a promise to produce a large amount of cash on short notice. If nothing sits behind that promise, the survivors face three unpleasant options: borrow against a business that just lost an owner, sell assets, or renegotiate terms with a grieving family.
The document was sound. Nobody arranged the money.
This is the most common failure we see, and it usually happens for an ordinary reason. The attorney drafts the agreement. The funding is somebody else’s job, and often nobody is quite sure whose. The agreement gets signed, everyone moves on, and the gap sits there for years.
How Do You Fund a Buy-Sell Agreement
Most owners fund a buy-sell agreement with life insurance, because it delivers cash at exactly the moment the obligation is triggered. The structure you choose changes both the tax result and the estate consequences.
Cross-Purchase
Each owner holds a policy on the others. When one dies, the survivors receive the proceeds personally and buy the interest directly. Survivors get a stepped-up basis in what they purchase, which matters if they later sell.
The drawback is arithmetic. Two owners need two policies. Four owners need twelve. Past three or four owners it becomes unwieldy, and some plans use an insurance trust to hold the policies instead.
Entity Purchase, Also Called Redemption
The company owns the policies and redeems the departing interest itself. One policy per owner, simple to administer, and easy to keep current as ownership changes.
This is the structure the Supreme Court disrupted in 2024. Read the next section before defaulting to it.
Disability Buy-Out
A disability buy-out policy funds the purchase when a partner cannot work but still holds equity. Most agreements name disability as a trigger and then rely on life insurance, which does not pay out because nobody died.
That leaves the working partner running the company alone while a former partner keeps half the ownership and half the distributions. The buy-out has to happen and no cash stands behind it. A disability buy-out policy provides that capital, so the departing partner exits on terms both sides agreed to in advance rather than through a negotiation neither of them wanted.
Hybrid
The agreement gives the surviving owners the first option to buy and requires the company to step in if they decline. It preserves flexibility, and it means the analysis below applies whenever the company ends up as the buyer.
How Did the Connelly Decision Change Buy-Sell Agreements
In Connelly v. United States, decided June 6, 2024, a unanimous Supreme Court held that life insurance proceeds a corporation receives to redeem a deceased shareholder’s shares count as a company asset when valuing the company for estate tax. A redemption obligation is not necessarily a liability that offsets that value.
Two brothers owned a building supply company. The company held life insurance on each of them to fund a redemption. When one brother died, the estate argued the insurance proceeds should not raise the company’s value because the money was earmarked to buy back his shares. The Court disagreed, and the shares were valued higher as a result.
Before Connelly, many advisors relied on a different reading from an earlier case. That reliance no longer holds.
What this means in practice. If your company owns the policies and the company is the buyer, the death benefit can increase the taxable value of the deceased owner’s estate. The insurance you bought to solve a liquidity problem can enlarge a tax problem at the same time.
Whether that costs anything depends on the size of the estate. For 2026 the federal estate tax exemption sits at $15 million per individual and $30 million for a married couple using portability, made permanent under the One Big Beautiful Bill Act, with a 40% rate above it. Most owners land under that. Owners of substantial closely held companies frequently do not, particularly once the business, real estate, and retirement accounts are added together.
Arizona adds no state estate tax, so Tucson owners face the federal question alone. That is a genuine advantage over owners in states that impose their own estate tax at far lower thresholds.
If your agreement is a company redemption funded by company-owned insurance, it deserves a review with your attorney and CPA. Cross-purchase and insurance-trust structures generally sit outside the Connelly issue, though each carries its own tradeoffs. This is coordination work rather than a document rewrite, and it is the heart of Business Exit Planning.
What Happens if the Valuation Is Out of Date
An out-of-date valuation quietly underfunds the agreement, because the coverage was sized to a number the company outgrew.
Say two owners signed an agreement six years ago valuing the company at $4 million and bought $2 million of coverage each. The company is now worth $7 million. The obligation is $3.5 million. The insurance covers $2 million. The survivor owes $1.5 million out of pocket at the worst possible moment.
Nothing went wrong. The business grew, which is the entire point of running one.
Two habits prevent this. Review the valuation method and the coverage amount on the same schedule, ideally annually. And prefer a formula or an appraisal requirement over a fixed dollar figure, because a fixed number is stale the day after it is written.
What Triggering Events Should Be Included
Death and disability belong in every agreement. Practitioners often describe the full set as the five Ds: death, disability, divorce, departure, and disqualification. The last three are the ones owners forget, and they cause the most trouble.
- Divorce. Without a provision, an ownership interest can end up divided in a divorce settlement, handing a former spouse a seat at the table.
- Disability. Define it precisely. A vague standard produces a dispute exactly when the company can least afford one.
- Voluntary departure. An owner who simply wants out needs a defined exit, or the negotiation happens under pressure.
- Bankruptcy or creditor claim. This is how an outside party acquires an interest nobody intended them to have.
- Termination for cause. Relevant when owners are also employees, which describes most closely held companies.
Frequently Asked Questions
Do I Need a Buy-Sell Agreement With Only One Other Owner
Two-owner companies arguably need one most. With two owners there is no third party to break a deadlock, and the departure of either one puts the whole business in play. Cross-purchase structures are also simplest at this size, since only two policies are required.
Can a Buy-Sell Agreement Set the Value for Estate Tax Purposes
Sometimes, and the requirements are strict. A price set in a buy-sell agreement can be respected for estate tax only if the agreement meets specific tests in the tax code, including being a bona fide business arrangement on terms comparable to an arm’s-length deal. Family-owned businesses face additional scrutiny. This is a question for your attorney and CPA rather than a box to tick.
What if the Business Cannot Afford the Insurance
Term life is the least expensive way to cover a large obligation, which is why it funds most buy-sell agreements. Some agreements also allow installment payments over several years, which lowers the immediate cash requirement while creating an obligation the surviving owners carry. Partial funding paired with an installment provision is a common middle path.
Who Should Own the Life Insurance Policies
It depends on the structure, and after Connelly the answer deserves fresh attention. Individual owners hold the policies in a cross-purchase. The company holds them in a redemption. A trust can hold them in either arrangement. The ownership choice drives basis, estate inclusion, and administrative burden, so it is worth deciding deliberately rather than by default.
How Often Should the Agreement Be Reviewed
Annually alongside the valuation, and immediately after any ownership change, a significant growth year, a divorce, or a change in tax law. The Connelly decision is a good example of the last category.
How We Coordinate Buy-Sell Funding at Global Investment Strategies
We do not draft buy-sell agreements. Your attorney does that, and it is legal work that belongs with legal counsel.
Our work sits on the funding side. We check whether the coverage still matches the obligation, whether the ownership structure creates an estate problem, and whether the valuation method in the document reflects what the company is actually worth today. We do that alongside your attorney and your CPA, because a change to the funding structure affects the document they drafted and the return they prepare.
We have coordinated planning for Tucson business owners since 2009. Insurance is one part of it, which is why Life Insurance Planning and succession planning are the same conversation here. For owners weighing an internal transfer instead, our guide to Management Buyout vs ESOP covers the alternatives.
Check Whether Your Agreement Is Actually Funded
If your buy-sell agreement is more than three years old, two questions are worth answering this month. Does the coverage still match what the company is worth? And does the ownership structure still make sense after Connelly?
We work with owners across Tucson, Oro Valley, Marana and the Catalina Foothills, alongside your attorney and CPA. Request a private conversation and we will review what your agreement promises against what is actually standing behind it.
Global Investment Strategies provides educational planning concepts and works alongside your qualified legal, tax, and financial professionals. This article is educational and is not individualized tax, legal or financial advice. Review any buy-sell agreement or funding change with your attorney and CPA before acting.
