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Buy-Sell Agreement

The contract between co-owners of a business that says what happens to an owner's share when they die, leave, divorce or go bankrupt - who must or may buy it, at what price, and with what money.

Informational only - this is not legal advice. These definitions explain general legal vocabulary in plain English. They are not advice about your situation, reading them creates no attorney-client relationship, and the law differs from state to state and changes over time. For advice you can rely on, speak to a lawyer licensed in your state.

What it means

A buy-sell agreement is a pre-arranged answer to the question every closely held business eventually faces: what happens to an owner's interest when the owner is no longer there. It names the triggering events - death, disability, retirement, termination of employment, divorce, personal bankruptcy, an attempt to sell to an outsider - and for each one says whether the company or the other owners must buy the interest, may buy it, or have a right of first refusal, and whether the departing owner or their estate must sell. It may be a standalone contract or a set of provisions inside an operating agreement or shareholders' agreement.

The price mechanism is where these agreements succeed or fail. Common approaches are a fixed price the owners agree to update periodically and usually forget to, a formula tied to earnings or book value, or an appraisal by one or more valuers at the time of the trigger. Payment may be a lump sum or instalments over a term, and death triggers are often funded with life insurance the company or the other owners hold on each owner. A recent Supreme Court decision confirmed that life insurance proceeds a corporation receives to fund such a redemption count toward the corporation's value for federal estate tax purposes, which changed the arithmetic of the insurance-funded structure for many family businesses.

A well-drafted agreement also carries drag-along and tag-along rights for a sale of the whole company, restrictions on transferring interests to outsiders, and sometimes a shotgun clause under which one owner names a price and the other chooses whether to buy or sell at it. Without an agreement, the default is the state's entity statute: an heir or an ex-spouse may become a co-owner, and a departing owner may be able to force a dissolution or be stuck holding an interest no one is obliged to buy.

Where this comes from

Buy-sell agreements are contracts governed by state law and by the state's corporation or LLC statute, which sets what transfer restrictions are enforceable (for example Model Business Corporation Act § 6.27 and Delaware General Corporation Law, 8 Del. C. § 202, on restrictions on transfer of shares). For federal estate tax purposes, Internal Revenue Code § 2703, 26 U.S.C. § 2703, sets when a buy-sell price is respected in valuing a decedent's interest, and Connelly v. United States, 602 U.S. 257 (2024), holds that insurance proceeds received to fund a redemption are included in the corporation's value.

When people hire a lawyer for this

Co-owners without an agreement should have one drafted while they are still on good terms, because the document is far harder to negotiate once a trigger is in sight. Owners who already have one should have it re-read when the business changes materially in value, when an owner marries or divorces, and when insurance funding is in place, since the estate tax treatment of that funding has recently shifted.

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Part of the LawyerLand plain-English legal glossary. Definitions are written from primary sources - statutes and court rules - and each entry states the authority it rests on, or says plainly when the doctrine is state law with no national rule.

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