Buy-sell and key-person coverage: funding the moment an owner leaves

When an owner leaves, the business should not leave with them

Most business owners spend years building something valuable. Far fewer build a plan for what happens if a co-owner dies, becomes disabled, or simply wants out. The coverage structures designed for that moment are not complicated. Skipping them can force a surviving partner to share a boardroom with a deceased owner's heirs, or to sell assets at a bad time just to stay solvent.

The planning gap is wide

Many owners who expect to step away have no funded mechanism for a clean handoff. A 2026 Chase survey found that while nearly half of small business owners expect to exit within the next decade, only a small share report a fully developed succession plan. An Edward Jones study found that only 37 percent of business owners have a financial advisor helping them prepare for the transition. That leaves a large population with valuable companies and no plan for the day one person leaves.

How a buy-sell agreement works

A buy-sell agreement is a legally binding contract that governs what happens to an owner's interest when a triggering event occurs. Death and disability are the most common triggers, though divorce and ownership disputes appear often enough that advisors refer to the "four Ds."

There are three main structures. In a cross-purchase, the surviving owners personally buy the departing owner's interest, each holding life insurance on the others. An entity or stock redemption agreement flips that: the business owns the policies and buys back the shares. A wait-and-see hybrid gives the business a first right of refusal before the surviving owners step in.

The structures carry different tax consequences. In a cross-purchase, the surviving owners may receive a step-up in cost basis on the acquired shares, which can matter when they eventually sell. In a redemption arrangement, that step-up generally does not occur.

The Connelly decision changed the math on redemption agreements

Redemption agreements funded with corporate-owned life insurance may now trigger a larger estate tax bill than they once did. In June 2024, the Supreme Court ruled unanimously in Connelly v. United States that life insurance proceeds a corporation receives to fund a share redemption increase the corporation's value for estate tax purposes, and the redemption obligation itself cannot offset that increase. The IRS collected an additional $889,914 from the estate involved. The decision reversed nearly two decades of prior valuation practice.

A redemption structure that worked cleanly before Connelly may now generate an unexpected estate tax exposure. With the estate tax exemption scheduled to fall from roughly $13.6 million to approximately $6.8 million per individual after 2025, more owners may face this issue than the old threshold suggested. The case also shows a separate, avoidable problem: the two brothers involved never kept their valuation provisions current, which gave the IRS a foothold. An unfunded or outdated agreement can be worse than none at all.

Funding the agreement with life and disability coverage

Life insurance can create the liquidity a buy-sell agreement needs. In a redemption structure, the business owns the policies and is the beneficiary. In a cross-purchase, each owner holds policies on the others. Either way, the face amount should track the purchase price written into the agreement, which means the insurance and the valuation need review together whenever the business changes materially.

Permanent life insurance can serve an added purpose. Accumulated cash value may help fund a buyout at retirement, when no death benefit is triggered.

Disability is statistically more likely than premature death, and a buy-sell agreement should address it. Disability buyout policies exist to fund this obligation, paying the buyout when an owner becomes permanently disabled rather than forcing the remaining owners to pull cash from operations.

Key-person coverage is a separate tool

Key-person insurance is distinct from buy-sell funding. The business owns a policy on an individual whose loss would significantly damage the company's finances, whether a founder, a lead salesperson, or a technical specialist. The business is both owner and beneficiary, and the proceeds can offset lost revenue or fund the cost of finding and training a replacement. Coverage sizing is not standardized across carriers, but it typically reflects the person's salary, their share of revenue, or a multiple of projected profit contribution. That figure should be revisited when the business grows or the person's role expands.

One compliance requirement applies to both key-person and buy-sell policies owned by a business. IRC Section 101(j) requires written notice and consent from the employee before the policy is issued for the death benefit to remain tax-free to the company. Businesses must also file IRS Form 8925 annually to report employer-owned life insurance contracts.

Where this fits in the financial plan

Buy-sell and key-person coverage address a specific risk that many owners overlook: the possibility that one person's exit ends what many people worked to build. They function as financial planning instruments, not products bolted onto a business problem. An independent advisor can help owners evaluate which agreement structure may suit current tax law, review existing agreements against the implications of Connelly, and keep the coverage amount aligned with actual business value over time.

This article is general information, not financial, tax, or legal advice. Coverage, tax treatment, and suitability depend on your specific situation and should be reviewed with your advisor and tax counsel.