What is the difference between a cross-purchase and an entity-purchase agreement?

In a cross-purchase agreement, the remaining owners individually buy the departing owner's share. In an entity-purchase (or stock-redemption) agreement, the business itself buys back the interest. Cross-purchase gives the buyers a stepped-up cost basis but gets complicated with many owners; entity-purchase is simpler to administer but the basis benefit goes to the company, not the individuals.

How is the value of a business set in a buy-sell agreement?

Common methods include a fixed price the owners agree to update annually, a formula (such as a multiple of earnings or book value), or an independent appraisal at the time of a triggering event. Many agreements combine approaches: for example, an agreed price that defaults to an appraisal if it has not been updated within 12 months.

How are buy-sell agreements usually funded?

Life insurance is the most common funding source for death triggers because it provides tax-free cash exactly when it is needed. Disability buyout insurance covers disability triggers. For retirement or voluntary exits, owners often use installment payments, a sinking fund, or a combination. Funding is what turns the agreement from a promise into something that can actually be performed.

Do I need a buy-sell agreement if I own my business alone?

A solo owner with no co-owners generally does not need a traditional buy-sell agreement, though a succession plan or a one-way buy-sell with a key employee or family member can serve a similar role. Buy-sell agreements are essential the moment there are two or more owners, because they prevent disputes over what happens when one of them leaves.

Buy-Sell Agreement Template: How to Write One

Q: What is a buy-sell agreement?

A buy-sell agreement is a legally binding contract among the co-owners of a business (or between the owners and the company) that controls what happens to an owner's share if they die, become disabled, divorce, retire, or want to exit. It sets who can buy the departing owner's interest, how the price is determined, and how the purchase is paid for.

Learn how to write a buy-sell agreement for your business. Covers triggering events, valuation, funding with life insurance, and common drafting mistakes.

A buy-sell agreement is the contract most co-owned businesses know they should have and most never get around to writing, until a partner dies, divorces, or walks out, and the remaining owners discover there are no rules for what happens next. By then the disagreement is personal, expensive, and often ends up in court.

This guide explains what a buy-sell agreement is, the structures you can choose from, how to value the business, how to fund the buyout, and the drafting mistakes that quietly make these agreements useless when they're finally needed.

What is a buy-sell agreement?

A buy-sell agreement (sometimes called a buyout agreement or business continuity agreement) is a legally binding contract that governs the transfer of an owner's interest in a business. It answers three questions in advance:

When can or must an ownership interest change hands?
Who has the right (or obligation) to buy it?
How much is it worth, and how will the purchase be paid for?

It functions like a prenuptial agreement for a business. Everyone agrees on the rules while relationships are healthy, so that no one is negotiating under pressure during a death, a falling-out, or a divorce. The agreement can stand alone or be built into an operating agreement or shareholder agreement, depending on the entity type.

Why every co-owned business needs one

Without a buy-sell agreement, an owner's share passes according to their will, state intestacy law, or a divorce court, which can leave the surviving owners in business with a deceased partner's spouse, an ex-spouse, or heirs who have no interest in or knowledge of the company.

A well-drafted agreement prevents several specific disasters:

An unwanted co-owner. It stops shares from landing in the hands of an heir, creditor, or ex-spouse the other owners never chose to partner with.
A forced fire sale. It gives the remaining owners the first right (or the obligation) to buy, rather than racing an outside buyer.
Valuation fights. A departing owner thinks the business is worth a fortune; the buyers think it's worth far less. The agreement fixes the method ahead of time.
A cash crunch. It pairs the buyout obligation with a funding source so the buyers aren't forced to drain the company or take on debt.

Types of buy-sell agreements

Cross-purchase agreement

Each remaining owner personally buys a proportional share of the departing owner's interest. This works cleanly with two or three owners and gives the buyers a stepped-up cost basis, which reduces their capital gains tax if they later sell. The downside: with many owners, the number of insurance policies and transactions becomes unwieldy.

Entity-purchase (stock-redemption) agreement

The business itself buys back the departing owner's interest. Administration is simpler (one policy, one buyer), and it scales better to larger ownership groups. The trade-off is that the surviving owners don't get the individual basis step-up, and the company must have or raise the cash.

Hybrid (wait-and-see) agreement

The agreement gives the company the first option to buy; whatever it declines, the individual owners can purchase. This defers the cross-purchase-versus-redemption decision until a triggering event actually happens, when the tax and cash picture is clearer. It's the most flexible structure and increasingly the default for sophisticated agreements.

One-way buy-sell

Used when one owner plans to buy out another over time, or when a sole owner arranges for a key employee or family member to purchase the business at retirement or death. Only one direction of purchase is contemplated.

Triggering events: what sets the agreement in motion

The heart of a buy-sell agreement is its list of triggering events: the circumstances that create a right or obligation to buy and sell. Spell these out precisely:

Death of an owner
Permanent disability (define it clearly, e.g., unable to perform duties for 180 consecutive days, confirmed by a physician)
Retirement or reaching a stated age
Voluntary withdrawal or resignation
Divorce, so an interest awarded to an ex-spouse can be bought back
Personal bankruptcy or a creditor attempting to seize an owner's interest
Termination of employment, if ownership is tied to working in the business
Loss of a professional license, critical for law, medical, or accounting practices

For each trigger, state whether the buyout is mandatory ("the company shall purchase") or optional ("the remaining owners shall have the right to purchase"). Death is usually mandatory; a voluntary exit is often optional with a right of first refusal.

How to value the business

Disagreement over price is the single most litigated part of buy-sell agreements. Pick a method and write it down:

Agreed (fixed) value

The owners set a value and agree to revisit it, ideally annually, by signing a certificate of value. Simple, but dangerous if neglected: a price set five years ago and never updated can be wildly off. Always pair it with a fallback.

Formula

A predefined calculation, such as a multiple of EBITDA, a multiple of revenue, or book value plus a goodwill factor. Formulas are objective but can produce odd results during unusual years, so define which financial statements and time periods apply.

Independent appraisal

A qualified business appraiser determines fair market value at the time of the triggering event. The most accurate and the most expensive and time-consuming. Many agreements use it as the default if an agreed value hasn't been updated within 12 months.

A common best-practice approach combines them: an agreed value that the owners certify annually, defaulting to an independent appraisal if the certificate is stale. Also specify how appraisers are chosen and who pays for them.

Funding the buyout

An agreement that obligates a buyout without a way to pay for it is just a lawsuit waiting to happen. Match each trigger to a realistic funding source:

Life insurance funds death triggers. The company or owners hold policies on each owner; on death, the tax-free proceeds fund the purchase. Whether the company (entity-purchase) or the individuals (cross-purchase) own the policies affects taxes and should match your agreement structure.
Disability buyout insurance covers disability triggers, which life insurance does not.
Installment payments spread a voluntary or retirement buyout over several years, usually with interest and secured by a promissory note. This protects company cash flow but leaves the seller exposed to future business performance.
Sinking fund: the business sets aside reserves over time. Reliable but ties up capital.

Most agreements blend sources: insurance for death and disability, installments for retirement and voluntary exits.

How to write a buy-sell agreement: step-by-step

Step 1: Identify the parties and the entity. Name every owner, the business, and its legal structure (LLC, S-corp, C-corp, partnership). The right structure shapes the tax treatment of any buyout.

Step 2: List the triggering events. Cover death, disability, retirement, voluntary exit, divorce, bankruptcy, and any profession-specific triggers. For each, state whether the buyout is mandatory or optional.

Step 3: Define the buyers and their priority. Specify who gets the first right to buy (the company, the other owners, or a hybrid) and the order in which rights apply.

Step 4: Set the valuation method. Choose agreed value, formula, appraisal, or a combination, and define exactly how and when it's calculated.

Step 5: Specify the funding. Tie each trigger to a funding source and state who owns and pays for any insurance policies.

Step 6: Set the payment terms. Down payment, interest rate, installment schedule, and security (such as a pledge of the purchased interest) for any amount not paid in cash.

Step 7: Add transfer restrictions. Prohibit owners from selling or pledging their interest to outsiders without first offering it under the agreement (a right of first refusal).

Step 8: Add governing law, dispute resolution, and signatures. Specify the controlling state's law, how disputes are resolved (mediation or arbitration is common), and have every owner sign. For entities, confirm the signatory has authority to bind the company.

Common mistakes that make a buy-sell agreement fail

Never updating the valuation. A fixed price set years ago and forgotten is the most common defect. Calendar an annual review, or use an appraisal fallback.

Leaving the buyout unfunded. Obligating a purchase without a funding mechanism forces owners to drain the company or borrow at the worst possible time. Funding is not optional.

Mismatched insurance ownership. Holding policies in the wrong structure (entity-owned policies for a cross-purchase agreement, or vice versa) creates avoidable tax problems and can leave the buyout short.

Vague triggering events. "Disability" without a definition invites argument over whether an owner is actually disabled. Define each trigger with objective criteria.

Ignoring divorce. A business interest is often a marital asset. Without a divorce trigger, an owner's ex-spouse can end up holding equity in the company.

Treating it as set-and-forget. Ownership changes, the business grows, tax law shifts. Review the agreement every few years and after any major event. The same discipline applies to the foundational documents it sits alongside, like your partnership agreement.

Buy-sell agreement vs. shareholder agreement

The two overlap but aren't the same. A shareholder agreement governs the ongoing relationship among owners: voting rights, board seats, dividend policy, and management decisions. A buy-sell agreement focuses narrowly on the transfer of ownership when someone leaves.

In practice, the buy-sell provisions are frequently written as a section within a shareholder agreement, an LLC operating agreement, or a partnership agreement rather than as a standalone document. Either way, the substance is what matters: clear triggers, a defined value, and real funding. If you're still mapping out the basics of how a binding contract is formed, start with the elements of a contract.

When to put a buy-sell agreement in place

The day a second owner joins. The best time to agree on exit rules is before anyone wants to exit.
Before bringing on investors, who will expect clear transfer and exit provisions.
When ownership percentages change or new equity is granted to employees.
After a major valuation change, so the price method still reflects reality.
Whenever an owner's personal circumstances shift: marriage, divorce, a health event, or approaching retirement.

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