When two or more people start a business together, everyone is focused on getting it off the ground. Few founders want to talk about what happens if one of them dies, becomes disabled, gets divorced, or simply wants out. But those events happen in almost every long-lived company, and when they do, the remaining owners, the departing owner and that owner’s family all need answers fast. A buy-sell agreement is the document that gives those answers in advance.
What a buy-sell agreement does
A buy-sell agreement is a contract among the owners of a business (and often the business itself) that controls what happens to an owner’s interest when certain events occur. It typically answers four questions:
- Which events trigger a buyout, and whether the buyout is required or optional
- Who buys the departing owner’s interest: the company, the other owners, or either
- How the price is set
- How and when the price gets paid
A buy-sell agreement can be a stand-alone contract, or its terms can be built into an LLC operating agreement or a corporation’s shareholder agreement. What matters is that the terms exist, are signed by everyone, and are kept up to date.
What Ohio law does if you don’t have one
For Ohio LLCs, the Ohio Revised Limited Liability Company Act (Chapter 1706 of the Revised Code) supplies default rules. Under R.C. 1706.411, a member is dissociated from the company on events such as death, the appointment of a guardian, a court finding that the member is incapable of performing member duties, or certain bankruptcy filings. Under R.C. 1706.412, a dissociated member loses the right to participate in the company’s activities and affairs, but keeps the right to the distributions the member would otherwise have received.
Notice what the statute does not do: it does not require the company or the remaining members to buy out that interest. Without a buy-sell provision, the result can be awkward for everyone. A deceased member’s estate or heirs may hold an economic stake in a company they have no say in and can’t easily sell, while the surviving owners keep sharing profits with someone who no longer contributes. Corporations face similar problems when shares pass to an heir or an ex-spouse who was never meant to be an owner.
Common triggering events
Most buy-sell agreements address some or all of the following:
- Death. The classic trigger, and usually a mandatory buyout so the family gets cash and the business stays with the people running it.
- Disability. The agreement should define disability carefully, for example by reference to a period of time unable to work, so there is no argument about whether it has occurred.
- Retirement or voluntary departure. Often an option rather than an obligation, sometimes with a notice period or a price adjustment for leaving early.
- Termination of employment. Particularly for owners who also work in the business; some agreements distinguish between leaving for cause and leaving without cause.
- Divorce. Lets the company or the other owners buy back any interest awarded to a non-owner spouse.
- Bankruptcy or a creditor’s claim. Keeps an owner’s interest from ending up in the hands of a creditor or trustee.
- Deadlock or an offer from an outsider. Some agreements include a right of first refusal, or a “shotgun” clause that lets one owner name a price at which the other must either buy or sell.
Who buys: redemption vs. cross-purchase
Redemption (entity purchase)
In a redemption agreement, the company itself buys back the departing owner’s interest. This is simple to administer, especially with several owners, because the company holds one insurance policy per owner and makes one purchase.
Cross-purchase
In a cross-purchase agreement, the remaining owners buy the departing owner’s interest directly, in proportion to their ownership. With many owners, this can mean many insurance policies, which is why some businesses use a trust or a separate entity to hold them.
Why the choice matters more after Connelly
In Connelly v. United States, decided unanimously in June 2024, the U.S. Supreme Court held that life insurance proceeds a corporation receives to redeem a deceased shareholder’s stock are a corporate asset for federal estate tax purposes, and that the company’s obligation to redeem the shares does not offset those proceeds. In practical terms, a company-owned policy used to fund a redemption can increase the value of the business, and of the deceased owner’s shares, for estate tax purposes. The Court noted that a cross-purchase arrangement is one alternative. Each structure has its own tax and practical tradeoffs, so this is a decision to make with your attorney and tax advisor, and it is worth revisiting if your agreement was signed before 2024.
Setting the price
Price disputes are among the most common fights between co-owners, so the valuation method deserves real attention. Typical approaches include:
- Agreed value. The owners set a price and update it on a schedule, for example every year. Simple, but it only works if the owners actually update it; a stale number can badly shortchange someone.
- Formula. A multiple of earnings, revenue or book value. Predictable, though a formula that fits a startup may not fit the same company ten years later.
- Independent appraisal. One or more qualified appraisers value the business at the time of the trigger. Usually the most accurate, but slower and more expensive.
The agreement should also say whether discounts for a minority interest or lack of marketability apply, what date the value is measured on, and who pays for the appraisal.
Funding the buyout
A buyout promise is only as good as the money behind it. Common funding tools include life insurance for death, disability buyout insurance for disability, installment payments under a promissory note (often with security and a reasonable interest rate), and company savings or a sinking fund. Many agreements combine these, using insurance where it’s available and installment terms for everything else. It is also common to cap how much the company must pay in any one year so a buyout doesn’t drain the cash the business needs to operate.
Common mistakes to avoid
- Using a generic form that doesn’t match how the business is owned or taxed
- Never updating an agreed value or the insurance amounts as the business grows
- Triggers with no funding, so the obligation exists but nobody can pay
- Forgetting that spouses or trusts may hold interests and should sign or consent
- Agreements that conflict with the operating agreement or bylaws
Getting started
If you co-own a business, pull out your operating agreement or shareholder agreement and look for a section on transfers, buyouts or dissociation. Ask yourself what would happen tomorrow if one owner died or wanted to leave: who would buy the interest, at what price, and with what money. If you can’t answer those questions from the documents, it’s time to put a plan in writing. Bring a list of owners, your current governing documents, any existing life or disability policies, and a recent balance sheet to your first meeting with counsel.
Vincent Esquire helps Ohio business owners plan for ownership changes before they happen, including buy-sell provisions that fit how their companies actually run. Learn more about our business law services or reach out to talk through your plans.
This article is for general informational purposes only and is not legal advice. Reading it does not create an attorney-client relationship. Laws change and every situation is different, so consult an attorney about your specific circumstances. Attorney advertising.
