How to Fund a Buy-Sell Agreement With Life Insurance

Your buy-sell agreement says who buys a partner's share. It usually doesn't say where the money comes from. Here's how life insurance funding works, in plain English.

10/6/20265 min read

If your business partner died tonight, who owns his half on Monday?

His spouse? His kids? His estate? You?

A lot of partners have an answer. Often it's something like, "We've talked about it." Sometimes there's even a signed buy-sell agreement in a drawer.

Here's the next question, and it's the one that matters: Where does the money come from?

A buy-sell agreement without funding is a promise with no checkbook. This article covers how owners use life insurance to fund one, in plain English. I'm Harvey Baker Jr., a licensed Texas agent in McKinney, and this is a conversation worth having before it's urgent.

What a buy-sell agreement actually does

A buy-sell agreement is a written contract between business owners. It sets the rules for what happens to an owner's share when certain things happen. Common triggers include:

Death
Disability that keeps an owner from working
Retirement or a planned exit
Divorce, where a spouse could end up with part of the business
An owner leaving or being bought out

A good agreement usually spells out who can buy the share, how the price gets set, and how it gets paid.

Your attorney writes this document, not me. I don't give legal advice. My job is the part most agreements gloss over: making sure the cash shows up when the agreement says it has to.

The funding problem nobody wants to talk about

Say your agreement says the surviving owner buys out the deceased owner's family at a fair price. Great. Now the surviving owner has to come up with that money. The options usually look like this:

Cash on hand. Most small businesses don't keep that much cash sitting around, and draining it can choke operations.
Borrowing. Possible, but lenders get nervous right after a business loses an owner. Not ideal timing.
Paying the family over time. The family waits years for their money, and they're tied to how well you run the business without their loved one. That can get tense fast.
Life insurance. The money arrives when the triggering event happens, which is exactly when it's needed.

None of these is automatically right. But you can see why a lot of owners look hard at the last one for the death trigger.

How life insurance funding works

The basic idea is simple:

Each owner is insured for roughly the value of their share.
If an owner dies, the policy pays out.
That money is used to buy the deceased owner's share from the family or estate.
The family gets paid fairly. The surviving owners keep the business.

Nobody has to sell equipment, drain the operating account, or sign a new loan at the worst possible moment.

There are two main ways to set this up:

Cross-purchase: The owners own policies on each other. When one dies, the others get the money and buy the share.
Entity redemption: The business owns a policy on each owner. When one dies, the business gets the money and buys back the share.

Each one has trade-offs around how many policies you need, who pays the premiums, and how the tax pieces work. That comparison deserves its own article. For now, know that the structure in the agreement and the way the policies are owned have to match.

How much coverage? Start with what the business is worth

Funding starts with a value. Your agreement should say how that value is set. Common approaches include:

A fixed price the owners agree on and update (or forget to update)
A formula, like a multiple of earnings or book value
An outside appraisal at the time of the triggering event

Hypothetical example for illustration only: Picture two partners who own a commercial cleaning company in Collin County, 50/50. Their agreement set the business value years ago, back when it was half the size it is now. If one partner died today, the family would be paid based on that old number, and the policies were sized to match it. The family could feel shortchanged, and the survivor could be stuck in a dispute. The fix isn't complicated: update the value, then check whether the coverage still lines up.

From there, underwriting looks at each owner's age and health, and carriers have their own rules about how much coverage they'll consider. Coverage, eligibility, and rates vary by carrier and health.

Don't forget the other triggers

Life insurance handles one trigger: death. Your agreement probably has others.

Disability. An owner who can't work but still owns half the company is a real problem, and it can happen to anyone. Some owners look at disability buyout coverage for this. Availability and eligibility vary.
Retirement or a planned exit. This is usually funded with savings, installment payments, or the cash value inside a permanent policy. Policy features vary by carrier.
Divorce or departure. These are usually handled with payment terms in the agreement itself.

The goal is to look at every trigger and ask the same question: "If this happened, where does the money come from?"

A few things owners should know before buying

The agreement and the policies have to match. Who owns the policy, who pays the premium, and who's the beneficiary should line up with what the agreement says. A mismatch can cause headaches when your family can least afford them.
Notice and consent rules can apply. When a business owns a policy on someone, federal rules generally require written notice and consent before the policy is issued. Have your CPA confirm the paperwork.
Tax treatment depends on your setup. How premiums and benefits are treated depends on the structure, your entity type, and compliance. Consult your tax or legal professional for advice specific to your situation.
Term or permanent? Some partners use term coverage for a set window. Others want permanent coverage that may build cash value to help with a retirement buyout later. There's no one right answer.
Review it when the business changes. New partner, big growth, a new loan, a partner getting close to retirement. The value, the agreement, and the coverage should move together.

I work alongside your attorney and CPA so the agreement, the tax side, and the coverage fit together.

The Handshake Test

Here's the whole article in two questions. Ask them with your partner this week:

"Is our deal written down? And is it funded?"

If either answer is "not really," you don't have a plan. You have a hope with a handshake. And age and health don't wait for busy season.

Get your Gap Map (free, 20 minutes)

The Gap Map is a one-page look at where your home, your business, and your exit still depend on one person. Three columns. Plain English. You keep it either way, whether you buy anything or not.

Call or text 430-373-7752 with the word MAP for a free one-page Gap Map. Or learn more at bakerlegacypartners.com.

Built by you. Protected without you.

Insurance products involve costs, limitations, exclusions, and suitability considerations. This article is educational and is not tax, legal, or financial advice.

Harvey Baker Jr., Licensed Texas Life, Accident & Health Agent, TX License #3470534. Coverage, eligibility, and rates vary by carrier and health.