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Two friends start a business. Twenty years later one of them dies, and the survivor suddenly has a new business partner: the deceased partner’s spouse, who knows nothing about the company and wants cash. This is the scenario buy-sell agreements exist to prevent. And the reason most buy-sell agreements actually work when the moment comes is life insurance, which supplies the money to buy out the deceased owner’s share before grief turns into a legal fight.
What a buy-sell agreement does
A buy-sell agreement is a binding contract between co-owners that sets what happens to an owner’s share when a triggering event occurs: death, disability, retirement, or sometimes divorce or bankruptcy. It fixes the price or the valuation formula in advance and obligates someone to buy and someone to sell. Without one, the deceased owner’s heirs inherit the shares and can hold them, sell them to a stranger, or demand a buyout at whatever price they imagine the company is worth. The surviving owners get no say.
The agreement answers who buys. The funding answers with what money. Life insurance is the standard funding mechanism because the need is sudden, large, and unpredictable in timing. Many owners pair it with key person insurance, which covers the operational hole rather than the ownership transfer. A $2 million buyout cannot be paid out of operating cash without gutting the company, and a loan taken under duress comes with terrible terms. An insurance policy converts an unknown future obligation into a known monthly premium. (For the term vs. permanent funding choice, see term vs. whole life.)
The two structures: cross-purchase and entity redemption
There are two main ways to structure the purchase, and the choice drives the tax treatment, the number of policies, and even the company’s valuation for estate purposes.
In a cross-purchase agreement, each owner buys and owns a life insurance policy on every other owner. When one owner dies, the survivors receive the death benefit personally and use it to buy the deceased owner’s shares directly from the estate. The insurance stays outside the company entirely.
In an entity redemption, also called a stock redemption, the business itself owns a policy on each owner and is the beneficiary. When an owner dies, the company receives the death benefit and uses it to redeem, buy back, the deceased owner’s shares.
The practical difference is policy count. An entity redemption needs one policy per owner no matter how many owners there are. A cross-purchase needs each owner to hold a policy on every other owner, so the count grows fast: with four owners, that is 12 policies. For two or three owners, the difference is trivial. For six or eight, cross-purchase becomes an administrative headache.
Why the structure choice got more important in 2024
For years the conventional wisdom was simple: few owners, use cross-purchase; many owners, use entity redemption. Then the Supreme Court decided Connelly v. United States in 2024 and changed the math.
The Court ruled that life insurance proceeds paid to a company under an entity redemption agreement increase the company’s value for estate tax purposes, even though the proceeds are earmarked to redeem the deceased owner’s shares. In plain terms, the insurance money counts as a company asset when valuing the estate, which can push the estate over tax thresholds and trigger a bigger tax bill.
Cross-purchase agreements do not have this problem because the proceeds never touch the company. They go directly to the surviving owners, who also get a stepped-up cost basis in the shares they purchase, reducing their capital gains if they later sell. Entity redemptions give the survivors no such basis step-up.
This does not make entity redemptions obsolete. They are still simpler to administer with many owners, and the company paying the premiums can feel fairer when owners differ in age and health. But after Connelly, any entity redemption deserves a fresh review with a tax advisor. A structure chosen five years ago may now carry a tax cost nobody modeled.
What the agreement needs beyond the insurance
The policies are only the funding. The agreement itself has to do the legal work, and several pieces get skipped.
First, the valuation method. Fix it now while everyone is friendly: a multiple of earnings, book value, an independent appraisal, or a hybrid. An agreement that says “fair market value” without defining it is an invitation to litigate.
Second, the triggering events beyond death. Disability buyouts are the most commonly neglected. A disabled partner who cannot work but still owns half the company is a slow-motion version of the same problem, and disability insurance can fund that buyout the way life insurance funds the death buyout.
Third, a funding mismatch check. Make sure the person obligated to buy is the same person or entity receiving the insurance proceeds. If the agreement says the surviving owners will purchase the shares but the company receives the death benefit, you have built a very expensive confusion.
Fourth, a review schedule. Revisit the agreement when valuations change, when owners join or leave, and when tax law shifts. An agreement drafted a decade ago probably misprices the company and may use a structure the current tax rules punish.
Getting it done
Buy-sell agreements live at the intersection of law, tax, and insurance, which means no single advisor covers all of it. The legal drafting belongs with a business attorney. The tax treatment belongs with a CPA, especially after Connelly. The funding design, policy types, amounts, ownership structure, belongs with an insurance professional who does business succession regularly.
The premium for the policies is a modest operating cost. The cost of not having the agreement is a partnership dispute at the worst possible moment, a forced sale, or a stranger at the ownership table. For any business with more than one owner, this is not advanced planning. It is basic maintenance.
