When Buy–Sell Agreements Fail, It’s Never the Paperwork
- John McDonough
- Feb 3
- 3 min read
Most closely held businesses have a buy–sell agreement in place. Fewer have revisited whether it would actually function under current conditions.
When buy–sell agreements break down, it’s rarely because the documents were poorly drafted. More often, the structure and funding were never aligned with how the business evolved over time.
This article summarizes key insights from a recent webinar hosted in partnership with Pinney Insurance, focused on how high-performing business owners structure and fund buy–sell agreements to ensure continuity and control when the unexpected happens.
The Real Reason Buy–Sell Agreements Break
The same patterns tend to surface:
Agreements were established once and left unchanged
Valuations lagged behind economic reality
Funding assumptions depended on favorable timing
Limited coordination between liquidity, governance, and family considerations
This is where well-meaning legal design encounters financial reality. Without preparation, the outcome is rarely predictable.
When a partner exits without liquidity in place, decisions are compressed. Capital must be sourced quickly. Families may inherit ownership positions they never anticipated. Questions of value, timing, and control become difficult to resolve efficiently.
The challenge is not the exit itself. It is the absence of liquidity at the moment it matters.
Understanding the Three Buy–Sell Structures
Cross-purchase arrangements are often effective for businesses with a limited number of owners, particularly where basis considerations and clean ownership transitions are priorities. They require coordination, but when maintained properly, they tend to perform as intended.
Entity redemption structures offer administrative simplicity and centralized policy ownership. At the same time, they introduce considerations around cash flow, tax treatment, and—more recently—valuation implications that deserve careful review.
Hybrid structures exist to address complexity as businesses grow and ownership evolves. In many cases, they provide a practical balance, allowing flexibility while managing tax exposure and liquidity needs over time.
Structure establishes the framework. Funding determines whether the framework holds.
Funding Must Evolve with the Business
As businesses grow, static funding becomes a liability.
Effective buy–sell arrangements are reviewed and adjusted over time:
Valuations are updated
Ownership changes are reflected
Insurance design remains aligned with the governing agreement
When coverage no longer reflects reality, the agreement itself becomes less reliable.
The Connelly Decision: Why Ownership Now Matters More Than Ever
The Supreme Court’s Connelly decision clarified that entity-owned life insurance may be included in business valuation for estate tax purposes.
For many owners, this has introduced new considerations:
Higher reported enterprise values
Increased estate tax exposure
Unintended consequences for families
The decision did not invalidate buy–sell planning. It underscored the importance of coordination. Ownership of insurance, structure of the agreement, and valuation methodology now intersect more directly than before.
In certain circumstances, cross-purchase structures may help mitigate these effects. What matters most is that legal, tax, and insurance decisions are evaluated together rather than in isolation.
Case Study: When Planning Is Done Right
Scenario: Two partners with equal ownership operating under a cross-purchase agreement.
Each owner owns a policy on the other
Valuations are updated regularly
Coverage reflects current economic reality
Outcomes:
Clean ownership transition
Step-up in basis for the surviving owner on the acquired interest
Family receives liquidity, not control
No inflation of company value from entity-owned insurance
This is how buy–sell planning is supposed to work.
Buy–sell agreements that function over time tend to share a few characteristics: structure aligned with ownership reality, insurance owned and designed intentionally, funding that holds up under stress, and ongoing review as the business evolves. When there is uncertainty about whether an agreement would function today, that uncertainty itself is informative.
The Questions Every Owner Should Ask
When was the agreement last reviewed?
Is there a buy–sell agreement in place at all?
Who owns the insurance?
Would your partner’s family consider the outcome fair?
Watch the Full Webinar
The accompanying webinar explores buy–sell structures, funding mechanics, and post-Connelly considerations in greater depth, with a focus on how experienced owners approach continuity planning. Watch the full session below.
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