The Test Every Buy-Sell Agreement Must Pass
A buy-sell agreement sets the legal obligation. Whoever holds the right to purchase the departing owner’s interest under the agreement is obligated to pay the agreed price when a triggering event occurs. That obligation is binding — but it is only executable if the money exists.
The test is this: if a triggering event happened today, would the buyers actually have the money to complete the purchase?
An unfunded agreement fails that test by design. The buyers have the obligation without the capital. A funded agreement passes it — the capital is in place before the triggering event, not scrambled for after.
What an Unfunded Buy-Sell Agreement Is
An unfunded buy-sell agreement creates a legal right and obligation to buy and sell ownership interests when specified triggering events occur. The agreement sets the price or a pricing formula. It defines the triggers. It says who buys and who sells.
It does not provide the capital to complete the purchase.
When a triggering event occurs under an unfunded agreement, the buyer must find the purchase price from their own resources: personal savings, a business line of credit, a bank loan, or a structured installment plan with the departing owner’s estate. Each of these sources has problems. Personal savings are rarely sufficient for a business purchase. Business credit lines may be frozen or limited following the triggering event. Bank loans for buying out a co-owner’s estate are difficult to obtain quickly. Installment plans leave the estate with a long-term receivable from a business that is now being operated without one of its founders.
What a Funded Buy-Sell Agreement Is
A funded buy-sell agreement has the same legal structure as an unfunded agreement — but it adds a dedicated capital mechanism to complete the purchase. The funding mechanism is matched to each triggering event covered by the agreement.
Three funding mechanisms are used in Georgia buy-sell planning:
- Life insurance funds the death trigger. Each owner holds a policy on each co-owner (cross-purchase) or the business holds a policy on each owner (entity redemption). When an owner dies, the death benefit provides the purchase price immediately — no loans, no installment plans, no personal savings scrambled in a crisis.
- Disability insurance funds the disability trigger. A buy-out disability policy pays monthly or in a lump sum when an owner cannot continue working. Without this, a disability trigger in the agreement creates the same funding problem as death — the obligation exists without the capital.
- Sinking funds fund the retirement or voluntary exit trigger. The business or individual owners accumulate capital over time in a dedicated account. When an owner retires or exits voluntarily, the sinking fund provides partial or full purchase capital. This is the least common funding method because it requires consistent discipline over many years.
Why Unfunded Buy-Sell Agreements Fail
Unfunded agreements fail at the worst possible moment. The triggering event — death, disability, divorce, departure — creates an immediate crisis for the surviving owners and the departing owner’s family. Adding a capital shortage to that crisis produces one of three outcomes:
The purchase does not happen. The surviving owners cannot raise the purchase price. The agreement’s deadlines pass. The departing owner’s estate or their heirs become de facto co-owners of the business — an outcome no one wanted and the agreement was supposed to prevent.
The purchase happens on bad terms. The surviving owners negotiate an installment plan with the estate. The estate receives less than fair value because the buyers have leverage. The heirs receive ongoing payments from a business they no longer control, dependent on a business relationship that may deteriorate.
The business is sold to fund the buyout. When neither of the above produces resolution, the most common outcome is selling the business entirely — often at a distressed price, often faster than the market requires, often not what any party actually wanted.
See common buy-sell agreement problems in Georgia for the full list of failure modes beyond funding.
What Connelly Changed for Life Insurance Funding
The 2024 U.S. Supreme Court decision in Connelly v. United States changed the estate tax treatment of entity-owned life insurance. Before Connelly, many practitioners assumed that death benefit proceeds used to fund an entity redemption buyout would offset the resulting increase in business value for estate tax purposes. Connelly held that this offset does not apply.
For Georgia business owners in taxable estates, this changes the funding structure analysis. The death benefit that funds the buyout now increases the estate tax value of the business without an offsetting deduction. The result can be an unexpected estate tax bill on top of the proceeds the estate uses to fund the sale.
Cross-purchase structures are less affected by Connelly because the surviving owners hold the insurance personally — the death benefit goes to them, not to the business, so it does not increase the business valuation. See cross-purchase vs. entity redemption for the full tax comparison.
How to Choose the Right Funding Method
The right funding method depends on the triggering events the agreement covers and the owners’ individual situations:
- If the agreement covers death: life insurance is always the right funding mechanism. It provides the exact amount at exactly the right moment. The only question is ownership structure — cross-purchase or entity redemption — and the answer depends on the number of owners and the Connelly analysis.
- If the agreement covers disability: a buy-out disability policy should be in place. Most buy-sell agreements cover disability; most are not funded for it. This is the most common gap in funded agreements.
- If the agreement covers retirement or voluntary exit: a sinking fund or a structured payment plan is the realistic option. Insurance does not fund voluntary events. Plan for this trigger explicitly rather than relying on business cash flow at the time of exit.
See what a funded buy-sell agreement costs in Atlanta for the pricing comparison between basic and funded structures.
