A buy-sell agreement tells everyone what happens if an owner dies, becomes disabled, or wants out. That is good. But a buy-sell agreement with no money behind it is just a promise, and promises do not pay for buyouts.
I ask a version of the same question in almost every planning meeting. If your partner died tomorrow, where would the money come from to buy out their family? Most owners do not have a good answer, and that is the gap key person insurance and funding are meant to close.
1. What key person insurance actually does
Key person insurance is a policy the business owns on the life of an owner or critical employee. If that person dies, the business receives the payout.
That money can cover the cost of finding and training a replacement, stabilize cash flow during a rocky transition, or fund an obligation to buy out an ownership interest. It is not one-size-fits-all, so the amount and structure should match what the business actually needs to survive that loss.
2. Why a buy-sell agreement needs funding, not just language
A written buy-sell agreement sets the terms, who buys, who sells, and at what price or formula. It does not create the cash to actually complete the transaction.
Without funding, the surviving owners often have to pay the departing owner or family out of company earnings over years, sometimes at the cost of growth, sometimes at the cost of the relationship. Life insurance owned specifically to fund the buyout removes that strain.
3. Cross-purchase versus entity-purchase structures
In a cross-purchase arrangement, each owner buys a policy on the other owners and uses the proceeds to buy that owner's interest directly.
In an entity-purchase arrangement, the business itself owns the policies and redeems the departing owner's interest. Each approach has different tax consequences and works better depending on the number of owners and their ages. This is a decision worth making deliberately, not by default.
4. Disability needs a plan too, not just death
Owners often insure for death and forget disability, but a long-term disability can be just as disruptive to a business, and it happens more often.
Disability buyout insurance, or at least a clear disability provision in the buy-sell agreement, keeps the business from being stuck supporting an owner who can no longer work while also trying to bring in someone who can.
5. Review your funding as the business grows
A buy-sell agreement funded correctly five years ago may be badly underfunded today if the business has grown. Valuations change, and insurance amounts need to keep pace.
I recommend owners revisit their buy-sell agreement and funding levels every few years, or whenever there is a meaningful change in ownership, valuation, or the number of partners involved.
If you have a buy-sell agreement gathering dust in a drawer, or none at all, let's take a look together. Reach out through blgattorney.com or call my Oklahoma City office to get it done right.