Buy-Sell Agreements: How Business Partners Protect Each Other
How a buy-sell agreement works, the difference between cross-purchase and entity redemption structures, and how life insurance funds the buyout.
A buy-sell agreement is a contract that lets the remaining owners buy out an owner who dies, becomes disabled, or leaves, and life insurance is the most common way to fund it.
What a buy-sell agreement does
A buy-sell pre-agrees the price and terms so a departing or deceased owner's share transfers smoothly, without forcing a fire sale of the business or dragging in an unwanted co-owner (such as a surviving spouse who has no role in the company).
Cross-purchase structure
Each owner buys a policy on each other owner. It is simpler and cleaner for 2 or 3 owners, and gives the surviving owners a stepped-up basis in the shares they buy. The number of policies grows quickly with more owners, since it takes n times (n minus 1) policies.
Entity redemption structure
The business itself owns the policies and buys back the departing owner's shares. It is simpler to administer when there are many owners, since there is only one policy per owner, but the surviving owners do not get the same stepped-up basis.
Sizing the funding
Each owner's share of business value determines the coverage needed to fund the buyout of that owner. Total coverage on any one owner should equal their ownership percentage times the agreed business value.
Worked example
A business worth 3,000,000 dollars with 3 equal owners needs roughly 1,000,000 of coverage per owner to fund a buyout of any one of them at their one-third share.
Ready to run the numbers?
Use the buy-sell funding calculator to get a specific quantity for your project.
Open the buy-sell funding calculator →Related guides
Last reviewed . Educational estimates only; local conditions and codes take precedence. Consult a qualified professional for site-specific decisions.