What a Buy-Sell Agreement Does
A buy-sell agreement (also called a buyout agreement or business continuation agreement) is a legally binding contract that controls what happens to a partner's ownership stake when they die, become permanently disabled, retire, or are forced to exit. Without it, a deceased partner's interest passes to their heirs — who may have no business experience, want to liquidate immediately, or become permanent silent partners with voting rights.
Life insurance is the preferred funding mechanism because it guarantees the buyout money exists the moment it's needed — the day of death — regardless of business cash flow, credit availability, or asset liquidity. You cannot sell a commercial building, collect receivables, or draw on a credit line overnight.
Three Buy-Sell Structures Compared
| Feature | Cross-Purchase | Entity-Purchase | Wait-and-See |
|---|---|---|---|
| Who owns the policy | Each partner owns policies on others | Business owns policies on each partner | Decided at trigger event |
| Who pays premiums | Individual partners | Business (after-tax) | Varies |
| Step-up in basis | Yes — heirs get FMV basis | No — capital gains exposure for survivors | Flexible |
| Complexity (3+ partners) | High — N×(N-1) policies | Simple — N policies | Most flexible |
| Best for | 2 partners, estate planning priority | 3+ partners, simplicity | Maximum future flexibility |
Coverage Calculation
Coverage equals your business valuation divided by the number of partners (for equal ownership structures). Common valuation methods:
- EBITDA multiple: 2–5× trailing 12-month EBITDA, depending on industry. SaaS: 5–8×. Services: 2–3×. Manufacturing: 3–4×.
- Revenue multiple: 0.5–2× annual revenue, common in professional practices
- Agreed value: Partners set a fixed number, updated annually in a written amendment — simplest and most dispute-resistant
- Book value: Balance sheet equity — typically understates true value for service businesses
3-Partner Example: $3M Business
$3M equally-owned business. Each partner's buyout value: $1M.
| Structure | Policies Required | Monthly Cost (Age 35, 20yr term) | Annual Premium |
|---|---|---|---|
| Cross-Purchase | 6 policies ($1M each) | $56/mo × 6 = $336/mo | $4,032/yr |
| Entity-Purchase | 3 policies ($1M each) | $56/mo × 3 = $168/mo | $2,016/yr |
Entity-purchase is cheaper to administer — half the policies, half the paperwork. But the step-up in basis advantage of cross-purchase can save surviving partners $50,000–$200,000 in capital gains taxes at the eventual business sale, depending on how much the business appreciates.
Tax Note: Entity-purchase proceeds may be subject to the corporate alternative minimum tax for C-corps. Always have a CPA review the structure before executing the buy-sell agreement. The legal document and the tax strategy must align.
Term vs. Permanent for Buy-Sell Funding
- Term life covers death only — cheapest option, appropriate when the buyout trigger is primarily death and partners plan to transition ownership within a fixed timeframe.
- Permanent life (whole life or universal life) accumulates cash value that can fund lifetime buyout triggers — disability, retirement, voluntary exit — not just death. More expensive but covers a broader range of triggering events.
- Disability buyout insurance is a separate product that funds the buyout if a partner becomes permanently disabled — death policies don't cover this scenario, and disability is statistically more likely than premature death for people under 65.
Cost Reference: Per-Partner Policy Costs
| Partner Age | Coverage | Term | Monthly Premium |
|---|---|---|---|
| Age 35 | $1M | 20yr | $56/mo |
| Age 40 | $1M | 20yr | $80/mo |
| Age 45 | $1M | 20yr | $121/mo |
Annual review is not optional. A $1M business in 2020 may be worth $3M in 2026. If the buy-sell and life insurance weren't updated, you have $2M of unfunded buyout exposure. Review both documents every year — or whenever a major revenue or valuation milestone is hit.
Best Carriers for Business Buy-Sell Policies
| Carrier | AM Best | Strength |
|---|---|---|
| Principal Financial | A+ | Complex business cases, large face amounts |
| Pacific Life | A+ | Business-owner underwriting, competitive rates |
| MassMutual | A++ | Permanent policies, estate planning integration |
| Lincoln Financial | A+ | High face amounts, universal life options |
| Protective Life | A+ | Lowest term rates for healthy business owners |
Frequently Asked Questions
What is a funded buy-sell agreement?
A buy-sell agreement is a legal contract between business partners that specifies what happens to an owner's interest when they die, become disabled, or exit the business. 'Funded' means there is a financial mechanism — typically life insurance — that guarantees the money to execute the buyout will actually be available when triggered. An unfunded buy-sell agreement is essentially a legal promise with no ability to pay.
How is the buyout price determined in a buy-sell agreement?
There are four common valuation methods: (1) Agreed value — partners set a fixed price updated annually in writing; (2) Formula-based — e.g., 3× trailing EBITDA calculated at the trigger date; (3) Independent appraisal — a third-party business valuator sets the price; (4) Book value — balance sheet assets minus liabilities. Most attorneys recommend agreed value with annual review because it's predictable, reduces disputes, and is the basis for sizing your life insurance coverage accurately.
What are the tax differences between cross-purchase and entity-purchase?
Cross-purchase: surviving partners buy the deceased's shares directly, establishing a new cost basis at the current fair market value (step-up in basis). When they eventually sell the business, capital gains are calculated from this new basis — often substantially reducing the tax bill. Entity-purchase: the business buys back the shares, no step-up occurs for surviving partners, creating a larger future capital gains exposure. The entity-purchase is simpler administratively but potentially costlier at exit.
How many policies does a 3-partner cross-purchase agreement require?
For N partners, a cross-purchase structure requires N × (N-1) policies. Three partners = 6 policies. Four partners = 12 policies. This administrative complexity (and cost) is why most 3+ partner businesses choose entity-purchase despite the step-up disadvantage, or use a Wait-and-See structure that defers the decision to the trigger event. A trusteed cross-purchase uses a single trustee to hold all policies, reducing administrative burden while preserving the step-up benefit.
What happens if we don't update our buy-sell agreement as the business grows?
This is the most common and costly mistake. A business worth $1M in 2020 may be worth $3M in 2026. If your buy-sell pegs the buyout at $1M and your life insurance only covers $500K per partner, the surviving partner either can't fund the buyout, takes on debt to do it, or the deceased partner's estate sues over underpayment. Buy-sell agreements and the life insurance funding them should be reviewed annually — at minimum every time the business completes a significant revenue milestone.