This quarter we partnered with our own TPG colleague, Brian Kelly, one of our insurance specialists, to discuss buy-sell agreements, an important planning tool that many business owners understand conceptually but often neglect to review as their companies grow.
For many entrepreneurs, building a successful business requires years of hard work, personal sacrifice, and financial investment. Owners spend significant time focused on growth, employees, customers, and operations. Yet one of the most important business planning documents frequently goes untouched for years: the buy-sell agreement.
While it may not receive the same attention as sales, hiring, or strategy, a well-designed buy-sell agreement can play a critical role in protecting the future of a business, its owners, and their families.
What Is a Buy-Sell Agreement?
A buy-sell agreement is a binding contract – often embedded in an operating agreement, shareholder agreement, or partnership agreement – that outlines what will happen if a business owner leaves the company due to death, disability, retirement, or another significant life event. The agreement answers three essential questions: Who can buy the departing owner’s interest? How will that ownership stake be valued? And how will that value be paid out?
By answering these questions in advance, business owners can avoid uncertainty and difficult negotiations during challenging circumstances. Instead of making important decisions during a crisis, the framework has already been established.
Why It Matters
Many privately owned businesses have multiple owners. If one owner passes away unexpectedly, their ownership interest may transfer to family members or heirs. While those family members are entitled to receive fair value of the ownership interest, they may not have experience running the company or an interest in remaining involved in the business.
At the same time, the surviving owners are often focused on maintaining business operations, supporting employees, and preserving profitability. The surviving family of a deceased partner (or one that’s become permanently disabled) isn’t necessarily a great replacement business partner. Without a clear agreement, these competing interests can lead to confusion, delays, and disputes. A well-structured buy-sell agreement provides clarity and helps ensure everyone understands the process before a triggering event occurs.
Funding the Purchase
Having an agreement is important, but it is only part of the solution. Business owners must also determine how the purchase will be funded.
Common funding sources include company cash reserves, bank financing, installment payments over time, and life insurance. Life insurance is frequently used because it can provide immediate liquidity when it is needed most. The insurance proceeds can be used to purchase the deceased owner’s interest, helping the family receive fair value while reducing financial strain on the business.
Without a funding strategy, surviving owners may be forced to borrow money, liquidate assets, or divert cash away from business operations.
The Most Common Mistake
One of the most common issues is not failing to create a buy-sell agreement. The more common problem is allowing an existing agreement to become outdated.
Businesses change over time. Revenues increase, ownership structures evolve, and company valuations often grow substantially. Insurance coverage that seemed adequate ten years ago may no longer support the current value of the business. As a result, a plan that once worked well may no longer accomplish its intended purpose, and that $1M life insurance policy may not make much of a dent in a $5M ownership interest repurchase obligation.
A Good Time for a Review
Business owners should periodically review their buy-sell agreements with legal, tax, insurance, and wealth advisor. A simple question can serve as an effective starting point: If something happened to one of the owners tomorrow, would the plan work exactly as intended?
If the answer is uncertain, it may be time for an update. And recent changes in tax laws may make an up-to-date review even more important.
A buy-sell agreement is more than a contract: it is a business continuity and succession planning tool that helps protect owners, families, employees, and business value. When reviewed regularly and properly funded, it can provide confidence that the business will remain on solid footing no matter what the future brings.
Brian Kelly, Insurance Specialist, and the TPG Wealth Management Team
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