Imagine two 55-year-old business partners who own a successful company 50/50. Ten years ago, when the company was worth roughly $2 million, they did what responsible business owners are supposed to do. They hired an attorney, put a buy-sell agreement in place, and agreed that each owner’s share was worth $1 million. Maybe they even bought life insurance to provide the money to buy out the other owner’s family if one of them died.
Then they went back to running the business.
Ten years later, the company is worth $7 million. Each owner’s interest might now be worth something in the neighborhood of $3.5 million, but nobody has looked at the buy-sell agreement since the day it was signed. The valuation provision still reflects a much smaller company, the life insurance hasn’t been updated, and neither owner has spent much time thinking about what would actually happen if the agreement had to be used tomorrow.
Now imagine that one of them dies.
The surviving owner may suddenly discover that having a buy-sell agreement and having a buy-sell agreement that actually works are two very different things.
Why an Old Buy-Sell Agreement Can Become a Problem
A buy-sell agreement is supposed to answer some uncomfortable questions before anyone is forced to answer them during a crisis. What happens to your ownership interest if you die? What happens if your partner becomes disabled and can no longer work in the business? Can an owner sell to an outsider? What happens if one owner wants to retire, gets divorced, or simply wants out?
Those questions don’t stay the same just because the document answering them is sitting safely in a file cabinet. Businesses grow. Ownership changes. Debt gets paid down or added. Owners get older, their families change, and a company that once produced a few hundred thousand dollars of annual profit may eventually produce millions. Yet it is surprisingly easy for the agreement governing one of the owners’ largest assets to remain frozen in time.
This is particularly important when it comes to valuation. The American Bar Association notes that many existing buy-sell agreements contain dated provisions governing how a business will be appraised and what price will be established when a triggering event occurs. Those details can include the standard of value, the valuation date, the qualifications of the appraiser, and even how life insurance proceeds are treated. (American Bar Association)
The problem, then, usually isn’t that the owners failed to plan. They did plan. The problem is that they treated the buy-sell agreement as something to finish rather than something to maintain.
What Is Your Business Actually Worth Today?
Go back to our hypothetical $7 million business. If the owners signed an agreement years ago specifying that each interest was worth $1 million, what happens when one owner dies after the business has more than tripled in value?
The answer depends on what the agreement actually says. Some agreements use a fixed price. Others use book value, a multiple of earnings, an appraisal process, or some other formula. Each approach has advantages and disadvantages, but almost any valuation method can produce a strange result if the assumptions behind it no longer resemble the company that exists today. Recent professional guidance on buy-sell valuations specifically warns that agreements can sit untouched for years while the business grows, debt changes, markets shift, and the owners’ objectives evolve. (Brady Martz)
This is also why I wouldn’t assume that simply writing “$3.5 million” into our hypothetical agreement fixes everything. A company can change rapidly, and the value of a closely held business isn’t displayed on a screen every afternoon like the price of a publicly traded stock. A good agreement needs a sensible process for arriving at a value when the agreement is actually triggered.
That raises a useful question for any business owner with an existing agreement: If your partner died tonight, do you know how the purchase price would be determined tomorrow? If the answer requires digging through a ten-year-old document to find out, the agreement is probably worth reviewing.
Where Is the Money Going to Come From?
Knowing the purchase price is only half of the problem. Someone also needs to come up with the money.
Suppose our surviving owner is required to purchase the deceased owner’s $3.5 million interest. That doesn’t mean he has $3.5 million sitting in a checking account. In fact, it’s entirely possible to own half of a valuable and profitable business while having nowhere near enough personal liquidity to purchase the other half.
Life insurance is commonly used to solve this problem. Depending on how the agreement is structured, the owners or the company can maintain policies designed to provide liquidity after an owner’s death. Other arrangements can involve installment payments, borrowing, company cash or some combination of funding sources. The right structure depends on the business and the owners, which is one reason the legal agreement and the financial plan shouldn’t be developed independently of one another.
Insurance also creates another maintenance problem. A $1 million policy might have adequately funded a buyout when the company was worth $2 million. If the company is now worth $7 million and the policy is still $1 million, the owners haven’t really solved the liquidity problem. They have funded part of it.
And funding shouldn’t be evaluated only for death. An owner can survive a serious illness or accident but become permanently unable to work. Depending on the agreement, that could create a requirement to purchase the disabled owner’s interest without the death benefit everyone assumed would provide the money.
What Happens If My Business Partner Becomes Disabled?
Death is actually one of the cleaner scenarios to think through. Long-term disability can be much messier.
Imagine one of our two owners suffers a medical event at 55 that prevents him from ever returning to work. He is still alive. He may still own half the company. He may depend on distributions from the business to support his family, while the other owner is now doing substantially more of the work required to keep that business running.
What happens next depends heavily on the agreement. Does disability trigger a mandatory buyout? How is disability defined? How long does an owner have to be disabled before a purchase occurs? How is the business valued at that point, and where does the money for the purchase come from?
These aren’t pleasant questions, which is probably one reason owners don’t spend much time discussing them. But that’s precisely the point of a buy-sell agreement. You want to answer difficult questions while two healthy business partners are sitting around a conference table, not after something has happened and their financial interests are suddenly very different.
Could My Partner’s Spouse End Up Owning Half the Company?
This is another question worth understanding before it becomes relevant.
Business owners tend to think about succession in terms of their partner. But every owner has a life outside the company. There may be a spouse, children, an estate plan, trusts, creditors or a divorce proceeding involved. The company’s governing documents can restrict transfers or require an interest to be purchased after particular events, but the precise outcome depends on the agreement and applicable law. Divorce creates its own complications, and the ABA notes that a buy-sell agreement’s stated value isn’t necessarily binding on a divorce court when determining the value of a business interest. (American Bar Association)
For our hypothetical owners, the practical objective is probably pretty simple. If I started this company with Bob, I presumably chose to be Bob’s business partner. That doesn’t necessarily mean I want to spend the next decade running the company with Bob’s spouse, children, estate or ex-spouse.
A properly designed agreement can establish what is supposed to happen before those interests collide. But again, the important question isn’t merely whether you have an agreement. It’s whether the agreement you have still produces the result you and your partner actually want.
Life Insurance Doesn’t Automatically Solve the Problem
There is a real case that illustrates just how important the details can become.
Michael and Thomas Connelly were brothers and the only shareholders of Crown C Supply, a building-materials company. Crown had purchased $3.5 million of life insurance on each brother, and their agreement provided a mechanism for the company to redeem the shares of a deceased owner. After Michael died, the treatment of those insurance proceeds became part of a dispute over the value of his shares for federal estate-tax purposes. The case eventually reached the U.S. Supreme Court. (Supreme Court)
In 2024, the Supreme Court unanimously held in Connelly v. United States that Crown’s obligation to redeem Michael’s shares did not automatically reduce the value of the company by an offsetting amount for estate-tax valuation purposes. In other words, the life insurance proceeds received by the corporation mattered when determining the company’s value. The Court was careful not to say that a redemption obligation could never reduce a company’s value, but it rejected the argument that these obligations necessarily offset the insurance proceeds. (Supreme Court)
The important lesson for most business owners isn’t the finer point of estate-tax law. It’s that “we have life insurance to fund the buy-sell” isn’t the end of the analysis. Who owns the policy, who receives the proceeds, how the purchase is structured, how the company is valued and what the tax consequences might be all need to work together. The Supreme Court itself contrasted the Connellys’ entity-redemption structure with a cross-purchase arrangement and explained that the alternatives come with different advantages, risks and tax consequences. (Supreme Court)
That’s exactly why this isn’t something I would try to solve with a financial advisor working alone.
Who Should Review a Buy-Sell Agreement?
A buy-sell review is one of those areas where coordinated planning matters because several different questions are hiding inside what looks like a single document. An attorney needs to determine whether the agreement legally accomplishes what the owners intend. A CPA or other tax professional may need to evaluate the tax consequences of the structure. A qualified business valuation professional may be needed to determine what the company or an ownership interest is actually worth.
The financial advisor has a different role. I want to know whether the plan works financially. Is there enough insurance? Who owns it? If an installment purchase is contemplated, what does that do to the surviving owner’s cash flow? What happens to the deceased owner’s family financially? Does the transaction create a major estate-planning or liquidity issue? How does all of this interact with the owner’s personal investments, retirement plan and other financial goals?
No single professional needs to pretend to be all of those things. In fact, I’d be suspicious of anyone who does. The better approach is for the attorney, CPA, financial advisor and, when necessary, valuation professional to solve their respective parts of the same problem.
The Four Questions I Would Ask
You don’t need to become an expert in buy-sell agreements to figure out whether yours deserves another look. I would start with four areas: Price, Trigger, Funding and People.
Price: How will the business be valued if the agreement is triggered today? If the document contains a fixed price or formula, does it bear any reasonable relationship to the business that exists now?
Trigger: Exactly what causes the agreement to take effect? Death is the obvious one, but disability, retirement, termination, divorce and other events may matter depending on the agreement. Buy-sell agreements commonly address ownership changes arising from events such as death, incapacity or an owner’s departure, but the actual triggers are determined by the specific contract. (American Bar Association)
Funding: Once a price has been established, where does the money actually come from? Look at life insurance, disability coverage, available business and personal liquidity, borrowing capacity, and any installment provisions. Most importantly, make sure the funding has kept pace with the value of the company.
People: If something goes wrong, who ultimately owns the business? Think beyond your partner and consider spouses, children, estates and other potential successors. Then ask whether the agreement produces the ownership outcome both partners still want.
Those four questions won’t replace a legal review, and they aren’t supposed to. They’re a quick way of determining whether the agreement sitting in your files still resembles the plan you think you have.
How Often Should You Review a Buy-Sell Agreement?
I don’t think the useful answer is to pick an arbitrary date on the calendar and pretend every business needs exactly the same review schedule. What matters more is whether something material has changed.
A substantial increase in the company’s value is an obvious reason to review the agreement. So is a change in ownership, marriage or divorce, a major change in an owner’s health, approaching retirement, taking on significant debt, adding or losing key employees, changing the company’s legal or tax structure, or discovering that existing insurance coverage no longer comes close to funding the anticipated purchase.
There is also nothing wrong with periodically pulling the agreement out even when nothing dramatic has happened. Businesses have a way of changing gradually enough that the owners don’t notice how different the company has become. Ten years later, they may be operating a company several times larger than the one the agreement was written for.
The Agreement Isn’t the Plan
If you put a buy-sell agreement in place years ago, that was probably a good decision. The mistake isn’t that the document got older. The mistake is assuming that because the agreement still exists, the planning behind it must still work.
Think again about our two hypothetical owners. They did a lot right. They built a successful $7 million company. They planned for an owner’s death when the company was young. They may even have spent money on attorneys and insurance to make sure the surviving owner and the deceased owner’s family would be protected.
But the business kept growing after the planning stopped.
If the last time you looked at your buy-sell agreement was the day you signed it, that’s probably a pretty good reason to look at it again. You don’t need to assume something is wrong. You simply want to find out while both owners are still sitting at the table and can fix it together.
Because the worst possible time to discover what your buy-sell agreement actually says is when you finally need to use it.
