Why your business needs a buy-sell agreement, and how to make one

For privately held businesses, long-term success depends on effective day-to-day operations and the willingness to strategize for the future. One of the most critical tools for protecting ownership interests and business continuity is the buy-sell agreement. This legally binding contract outlines what happens if an owner exits the business due to death, disability, divorce, retirement or other circumstances.

Business owners often overlook the value of drafting a buy-sell agreement. Without a clear plan in writing, the departure of an owner can lead to disputes, financial strain and significant disruption to a thriving company. In this article, we’ll explore what buy-sell agreements are, why they are essential, and the key provisions every owner should understand, including triggering events, valuation methods, structure and funding.

What is a buy-sell agreement?

A buy-sell agreement is a contract that governs how an ownership interest will be transferred if a defined event (such as those listed above) occurs. This means it serves as both a business continuity tool and an exit strategy framework. These agreements are crucial for all businesses, regardless of entity type.

Family businesses in particular can benefit from buy-sell agreements, as they can prevent conflict, define what’s considered fair for future generations, and help keep ownership within the family when that is the shared goal.

Why buy-sell agreements are essential

A well-crafted buy-sell agreement aligns the goals of all owners and provides clarity for the future. It provides an orderly exit ramp for owners who wish to leave, discouraging impulsive decisions that could harm the company. It can also prevent ownership from falling into unintended hands—such as an ex-employee who is now working for a competitor, or a third party that opportunistically acquires shares from an owner looking for liquidity.

Beyond ownership alignment, buy-sell agreements are a cornerstone of effective succession planning because they provide a framework for orderly transitions into and out of the business.

Consider the example of a dental practice with two partners. If circumstances change abruptly and one is no longer able to work, the other partner may face an overwhelming patient load and difficult negotiations with the nonworking owner’s family.

With a buy-sell agreement, the partner who is still working can have the option to purchase the nonworking partner’s share under predefined terms. This can help the practice continue serving patients smoothly, and ensure a fair payout to the departing owner.

Buy-sell agreements also help avoid future conflicts. By setting expectations in writing, they remove ambiguity and reduce the likelihood of disputes among partners or between the business and the family of a departing owner. This clarity is especially valuable in family businesses, where personal relationships and business interests often intersect.

Key provisions of a buy-sell agreement

The most important provisions in a buy-sell agreement address what triggers a transaction, how ownership is valued, how the purchase is structured, and how it is funded.

1. Triggering events

A well-designed buy-sell agreement should clearly define the events that will trigger an action.

These typically include death, permanent disability, retirement, voluntary departure, termination of employment, bankruptcy and divorce. Each of these scenarios can have a profound impact on the business and its remaining owners.

Example: Three partners founded a professional services firm together. Years later, one partner went through a divorce. Without a buy-sell agreement, the partner’s ex-spouse could be awarded a portion of the business interest in the divorce settlement, potentially giving them influence over company decisions. To prevent this, a buy-sell agreement could include a provision that would require the departing partner to sell their shares to the remaining partners, ensuring ownership stays within the intended group and business operations remain stable.

2. Valuation methods

Valuation is often the most sensitive element of the agreement. The method chosen to value the business and the departing owner’s interest can have significant financial consequences for all parties involved. Common approaches include:

• A fixed price that is set and updated regularly
• A formula-based approach that ties valuation to earnings (e.g., EBITDA multiple) or book value
• An independent appraisal that is conducted at the time of the triggering event

Formula-based or independent appraisal approaches are more common because fixed valuations carry a significant risk: If the business grows or contracts faster than the update cycle, the price may be out of date when it matters most. Ultimately, the right choice depends on the complexity of the business and ownership’s goals with regard to transfers. 

3. Structuring the agreement

The structure of the buy-sell agreement determines who will purchase the departing owner’s shares and how the transaction will be executed. There are three basic structures:

• In a cross-purchase agreement, the remaining owners buy the shares of the departing owner. This is common in businesses with a small number of owners.
• In an entity redemption, the company buys the shares. Larger businesses tend to prefer this approach because of its simplicity.
• A hybrid structure combines elements of both types for flexibility.

Example: A second‑generation family‑owned distribution company adopts a buy‑sell agreement with tiered right of first refusal. When one sibling decides to retire, the agreement gives that sibling’s children the first opportunity to purchase the shares. If they decline or cannot fund the full purchase, the other family shareholders have the right to acquire the shares on a pro rata basis or in whatever proportion they agree upon.

If any shares remain unpurchased after both rounds, the company itself acts as the backstop, redeeming the balance to ensure the transaction is completed and the departing owner receives a full payout. This layered structure preserves balance among family branches and guarantees certainty of closing.

4. Funding the buyout

A buy-sell agreement needs a funding mechanism to be effective. The agreement should specify how a buyout will be financed to ensure that the transaction can be completed without placing undue strain on the business or the remaining owners. Common funding strategies include:

• Life insurance: Provides immediate liquidity for death-related buyouts.
• Disability insurance: Covers disability-triggered events.
• Cash reserves or sinking fund: Company sets aside funds over time.
• Loans or installment payments: Used if insurance and reserves are insufficient.

In many cases, owners layer these strategies. For example, an agreement can call for insurance proceeds to be used as immediate down payment, with the balance paid over several years through a structured seller note at terms designed to match the company's cash‑flow profile. This approach gives the departing owner or their family both immediate liquidity and a predictable income stream, while preserving the company's working capital

When using life insurance as a source of funding, it’s important to structure the agreement properly to prevent increased estate tax exposure. Equally important is timing: estate taxes are typically due within nine months of death, but if the buyout is paid via a multi‑year promissory note, the family may lack the cash to meet that obligation on schedule. Coordinating insurance structure, payment timing and tax planning from the outset is essential. Your J.P. Morgan team can tell you more about how to optimize the use of life insurance.

Implementation and maintenance

It’s best to create a buy-sell agreement as early as possible— either at the company’s formation (if there are multiple founders) or when new shareholders are added, as waiting until a triggering event can result in chaos and conflict. Once in place, the agreement should be reviewed regularly—we recommend doing so every two to three years—or after significant business or personal changes, such as substantial growth, restructuring, or changes in tax law.

Professional advisors are essential in creating and maintaining an effective buy-sell agreement. We recommend involving four types of specialists to make sure yours is properly crafted: Attorneys, to ensure that the agreement is legally enforceable; certified public accountants (CPAs), to assist with valuation and tax implications; financial advisors, to help design funding strategies; and insurance specialists, to set up appropriate coverage.

These experts can help you avoid some common pitfalls, such as failing to update the agreement as the business evolves, poor structuring, using vague language that leads to ambiguity, and neglecting to plan for unpredictable scenarios.

Buy-sell agreements and trust structures should not be drafted in isolation. Instead, they must be deliberately coordinated to address control, transferability, tax treatment and fiduciary obligations.

Engaging these experts from the start helps avoid costly mistakes and helps to ensure the agreement aligns with your business goals.

Conclusion

There is no “one size fits all” approach to buy-sell agreements. The structure you ultimately choose should reflect your values and long-term intentions for the business. For example, family businesses that want to encourage continued family ownership may structure their buy-sell agreements to discourage sales by compressing valuations or utilizing long-term seller notes. Some families require employment in the business as a condition of ownership, while others establish a safety mechanism that allows family members to leave the business without harming it. 

Further, buy-sell agreements shouldn’t be drafted in isolation. For example, many businesses use trusts in estate planning and wealth transfer. However, when ownership interests are held in trust, traditional buy-sell agreements often fail to account for the added legal, tax and governance complexities. This means it’s important to make a comprehensive plan.

All successful businesses will go through leadership transitions over time, and that means a buy-sell agreement can help safeguard the future of your business for your partners and family. It establishes clear rules for ownership transfers, valuation and funding, facilitating smooth transitions even in times of crisis.

If you already have a buy-sell agreement, we recommend reviewing it with your advisors. If you don’t have one, consider reaching out to your business partners about drafting a buy-sell agreement. Taking this proactive step can mean the difference between a controlled transition and a company-wide dispute.

We can help

For more about how you can create or update a buy-sell agreement that meets your needs, contact your J.P. Morgan team.