Succession & Estate

Buy-sell Agreements That Are Actually Funded

Turn a buy-sell clause into an instrument that performs: the right structure, a valuation mechanism someone runs every year, and funding that exists on the day the trigger fires.

  • Advanced
  • 10 min total
  • 13 chapters

What decision this helps you make: Which buy-sell structure to use, how the price gets determined, and where the money comes from when a shareholder dies, becomes disabled, divorces, or walks out.

What this topic is

A buy-sell agreement is a contract among the owners of a closely held business, and between them and the company, specifying what happens to an ownership interest on defined trigger events: death, disability, retirement, termination of employment, divorce, bankruptcy, or an attempted transfer to an outsider. It sets who buys, at what price, on what payment terms, and, in a competent one, from what source of funds.

Why it matters

Almost every closely held company has one, and a large share of them fail on the day they are needed. They fail because the price mechanism was never run, because the obligation was mandatory and the money was not there, or because the structure created a tax result nobody modelled. A buy-sell without funding is not a protection. It is an enforceable debt that matures at the worst possible moment, and it can force the sale of the business it was written to preserve.

Who should learn it

Owners of any multi-owner business, professional practice partners, family shareholders, and the advisers who draft, fund, and periodically stress-test these agreements.

What you will understand

  • The three structures (redemption, cross-purchase, and hybrid) and the basis, tax, and creditor consequences of each
  • How valuation mechanisms actually behave: fixed price, formula, and appraisal, with their failure modes
  • The funding options and their real cost, including what happens when the trigger is disability rather than death
  • The insurance tax traps: the transfer-for-value rule and the employer-owned life insurance notice and consent requirements

Prerequisites

Common misconception

"We have a buy-sell, so we are covered." Ask three questions of any agreement and most fail at least one. When was the price mechanism last run, with a real number attached? If the largest owner died tonight, where would the cash come from, in dollars, by Tuesday? And is the obligation mandatory on the company, or merely an option? A mandatory purchase obligation with no funding is worse than no agreement at all, because the estate can enforce it and the company must comply.