THE DANGER OF OUTDATED BUY - SELL AGREEMENTS (AND HOW TO FIX THEM)
By: Matthew W. Frank
A buy-sell agreement is one of the most fundamental—and frequently underappreciated—legal instruments for any closely held business with multiple owners. At its core, the agreement functions as a form of business continuity insurance: it provides a structured mechanism for transferring ownership interests upon the occurrence of certain triggering events, such as retirement, death, permanent disability, divorce, bankruptcy, or a voluntary withdrawal from the enterprise. These are not merely hypothetical possibilities—they are inevitabilities over a long enough timeline. A thoughtfully drafted buy-sell agreement anticipates these transitions and mitigates the risk of disruption by articulating who can or must buy, how interests will be valued, and how the transaction will be funded.
Beyond protecting the enterprise itself, the agreement plays a critical role in balancing competing interests—between founders and successors, between active and passive shareholders, and often between the business and the deceased or departing owner’s family. In the absence of such an agreement, or where one exists but is poorly maintained or inadequately tailored to the business’s current structure and value, ownership transitions can devolve into internal disputes, external litigation, liquidity crises, or in extreme cases, the forced sale or collapse of the company. In this respect, the buy-sell agreement is not merely a governance document—it is an essential safeguard for long-term viability.
Why Buy-Sell Agreements Go Stale
Despite its significance, the buy-sell agreement is often treated as a static, one-time formality—executed during the early stages of a business when relationships are amicable, valuations are low, and the future appears linear and predictable. Yet businesses, like the people who run them, evolve. Ownership structures change. Valuations increase. Partners come and go. Strategic goals shift. A buy-sell agreement that once reflected the realities of the business can, over time, become outdated, incomplete, or even counterproductive.
Too often, we encounter agreements that fail to account for new equity holders, use valuation formulas that no longer reflect the true market value of the business, or impose funding mechanisms—such as life insurance requirements—that were never implemented or maintained. Worse, some agreements set fixed prices or vague terms that invite conflict at precisely the moment when clarity is needed most. In this sense, the buy-sell agreement becomes a liability—not because it was poorly drafted, but because it was never revisited. Just as financial statements and tax strategies must be reviewed regularly, so too must the governance documents that underpin a company’s most critical transitions.
Common issues we see with outdated agreements include:
- Valuation methods or fixed prices that are now inaccurate or obsolete
- Provisions that don’t account for new owners or revised ownership percentages
- Buyout terms that no longer reflect the business’s cash flow or financing options
- Conflicts with updated estate plans or other governing documents
Left unaddressed, these issues can lead to disputes, delay transitions, and create unnecessary strain on the business and its stakeholders.
A Real-World Example: Lessons from the Connelly Decision
In Connelly v. United States, the U.S. Supreme Court confronted a question of substantial consequence for closely held business owners: how corporate-owned life insurance, used to fund a buy-sell agreement, should be treated for estate tax purposes. The case arose from a common planning scenario—two brothers jointly owned a business and had implemented a stock redemption agreement obligating the company to repurchase a deceased shareholder’s interest. To fund the redemption, the business acquired life insurance on each brother’s life.
Upon the death of one brother, the company received the insurance proceeds and used them to redeem his shares in accordance with the agreement. However, the IRS took the position that the insurance proceeds—although used for a buyout—nonetheless increased the fair market value of the company for estate tax purposes. As such, the value of the deceased owner’s shares was deemed to include a proportionate share of the insurance proceeds. The estate, in turn, was subject to significantly higher tax liability than anticipated.
The Supreme Court affirmed the IRS’s position, holding that corporate-owned life insurance earmarked for redemption does not reduce the company’s value; rather, it enhances it, because the policy is an asset of the corporation. This decision underscores a critical—and frequently misunderstood—distinction between cross-purchase and redemption structures in buy-sell planning. While the former keeps insurance proceeds outside the corporate valuation, the latter may inadvertently inflate the taxable estate.
Connelly serves as a cautionary tale for business owners and advisors alike: the structure and funding of a buy-sell agreement must be carefully coordinated with estate planning strategies. Simply having an agreement in place is not enough—its mechanics must align with the intended tax outcomes.
This decision underscores why the structure of your buy-sell agreement—and who owns the life insurance—matters.[1]
When to Review Your Agreement
We recommend reviewing your buy-sell agreement:
- Every 2–3 years
- After any major change in ownership or structure
- When the company’s value changes significantly
- In connection with estate planning updates
- Following tax law or regulatory changes
What to Look For
When reviewing your agreement, pay close attention to:
- Whether the valuation method is current, practical, and defensible
- How the buyout would be funded—through insurance, promissory notes, or financing
- Whether all relevant exit scenarios are covered
Whether the agreement aligns with your current estate plan and business goals
Final Thought
A buy-sell agreement is not a “set it and forget it” document. It should evolve with your business. Taking the time for a regular check-in with your legal and financial advisors is the best way to prevent unnecessary problems before they arise.
If you haven’t reviewed your buy-sell agreement in years—or aren’t sure one is in place—I can help. Contact me at (248) 740-5672 or email [email protected] to schedule a review and I can ensure your agreement still protects what matters most.
[1] 1 Connelly v. United States, 601 U.S. ___ (2024), available at https://www.supremecourt.gov/opinions/23pdf/23-146_i42j.pdf
