A buy-sell agreement keeps your business safe if a partner dies, gets sick, or leaves. Without one, your partner's spouse, kids, or a probate court could end up as your new co-owner. A buy-sell deal spells out what happens to each owner's share. It sets the price, the buyer, and how the buyout gets paid.
How a Buy-Sell Agreement Works
A buy-sell agreement is a contract between co-owners. It creates a buyout plan for when a trigger event happens. Common triggers include death, lasting disability, retirement, divorce, or bankruptcy.
The agreement says who buys the leaving owner's share, at what price, and how the deal is funded. This type of deal works for partnerships, corporations, and any limited liability company (LLC) with two or more owners.
Three Main Structures
There are three ways to set up a buy-sell agreement:
- Cross-purchase buy-sell. The other owners buy the leaving owner's share. Each owner holds a life insurance policy on the other owners to fund the buyout. This works best with two or three owners.
- Entity purchase (stock redemption). The business itself buys back the share. The company owns and pays for the insurance. This is simpler when there are many owners.
- Wait-and-see (hybrid). The company gets the first option to buy. If it passes, the other owners can buy the share instead. This adds more options when the future is not clear.
Why Funding Matters
A buy-sell agreement is only as good as its funding. If the deal says your partner's family gets $1 million for their share, someone must have $1 million ready. Life insurance is the most common way to fund the buyout. Each owner, or the company, holds a policy on every other owner's life.
When an owner dies, the death benefit pays for the buyout right away. Other options include payments over time, company savings, or a set-aside fund. But life insurance gives cash at the exact moment it is needed most.
Setting the Price
The agreement should spell out how to set the buyout price. Common methods include:
- A fixed price agreed on and updated each year
- A formula based on revenue, earnings, or book value
- A third-party appraisal at the time of the trigger event
Old price tags are one of the most common problems. A business valued at $500,000 five years ago may be worth $2 million today. Regular reviews keep the deal fair for everyone.
Tax Factors
The setup you choose affects capital gains and other tax results. In a cross-purchase buy-sell, the living owners get a stepped-up basis in the shares they buy. In an entity purchase, the company's basis stays the same. That can create tax issues later. An attorney can help you pick the setup that works best for your case.
What Happens When an Owner Dies Without One
Without a buy-sell agreement, a dead owner's share passes through their estate. That could mean a spouse, adult child, or court-named person becomes your new partner. They may not care about the business. They may not know how to run it. They may demand a quick cash buyout at the worst time.
Every business with more than one owner needs a buy-sell agreement. It is not just good planning. It is how you protect what you built.
For the complete Arizona walkthrough of business succession planning — buy-sell agreements, FLPs, key-person coverage, and grooming the next owner — read our pillar guide: Business Succession Planning in Arizona: The Complete Guide.