Funding Options for Buy/Sell Agreements—A Guide for Modern Business Professionals

Introduction: Building on the Buy/Sell Foundation

If you read our recent blog post about the critical importance of buy/sell agreements, you already appreciate how essential these contracts are for safeguarding your business’s continuity, your partners, and your legacy. Buy/sell agreements are truly one of the unsung heroes of business succession planning—they transform uncertainty into clarity, and potential chaos into smooth transitions. But recognizing their importance is only the beginning. The next—and arguably the most difficult—challenge is figuring out the best way to fund a buy/sell agreement when the time comes.

Throughout my career as an advisor and educator to business leaders, I’ve watched buy/sell agreements rescue companies from disaster—provided they were properly funded. It’s not enough to have an agreement on paper; you need a clear, actionable plan for how the buyout will actually be paid for. Let’s explore the funding options available, and how to choose the right one for your business.

What Is a Buy/Sell Agreement?

At its core, a buy/sell agreement is a legally binding contract between business owners that specifies what happens to an ownership share if one owner dies, becomes disabled, retires, gets divorced, goes bankrupt, or simply wants to exit the business. These agreements spell out not only who can buy the departing owner’s shares, but also the price, terms, and funding mechanism for the buyout.

• Definition: A buy/sell agreement governs the transfer of ownership interests after certain triggering events.
• Importance: It prevents disputes, keeps the business running smoothly, and protects the interests of all owners and their families.
• Typical scenarios: Death, disability, retirement, voluntary exit, divorce, or bankruptcy.

Why is this so vital? Imagine a thriving partnership abruptly losing a key owner—without an agreement, the result can be confusion, bitter disputes, and even business failure. The departing owner’s shares might fall into the hands of someone with no experience or interest in the business—maybe a spouse, child, or creditor. With a buy/sell agreement in place, everyone knows their rights, the process, and the value at stake.

When Do Buy/Sell Agreements Come Into Play?

Buy/sell agreements are especially important for closely held businesses—think partnerships, family-owned enterprises, and small corporations. The need typically arises when:

• An owner passes away unexpectedly
• An owner becomes disabled and can no longer participate
• An owner retires or decides to leave the business
• An owner faces divorce or bankruptcy, putting shares at risk of transfer to a third party
• Owners wish to provide certainty for their heirs and the remaining partners

In all these cases, having a plan for how ownership is transferred and—critically—how the departing owner will be compensated is essential.

How Do You Fund a Buy/Sell Agreement?

Signing a buy/sell agreement is step one. Step two is figuring out where the money will come from to fund the buyout. There are several approaches, each with their own advantages and drawbacks. Let’s examine four of the most common options:

• Business Cash Reserves: Using the company’s own savings.
• Buyers’ External Cash: Using the personal funds or borrowing power of the remaining owners.
• Internal Financing from Revenue: Paying for the buyout over time from future profits.
• Third-Party Funding (Insurance): Using proceeds from insurance policies to supply buyout funds without surrendering equity.

Business Cash Reserves: Pros, Cons, and Examples

Using cash reserves from the business itself is often the first method considered for funding a buy/sell agreement. In theory, it’s straightforward: when a buy/sell event occurs, the company pays out the departing owner from its bank account.

Pros:

• Immediate availability (if cash is on hand)
• No need for loans, interest payments, or outside parties
• Simplicity—no lengthy approval processes

Cons:

• Depletes working capital, which can limit growth and daily operations
• May not be enough cash available when needed, especially in smaller businesses or during economic downturns
• Reduces the business’s ability to weather emergencies or invest in new opportunities

Viability: This option works best for companies with strong, stable cash flows and substantial reserves. In reality, most small and mid-sized businesses find this solution impractical.

Example: Consider a regional retailer with $500,000 in reserves. When a co-owner retires, the business uses $300,000 to buy out their stake. Afterwards, the retailer struggles to keep up with inventory expenses and payroll, leaving the company financially vulnerable. The initial simplicity of the transaction quickly gives way to unexpected headaches.

Buyers’ External Cash: Pros, Cons, and Examples

Another method is for the remaining owners to use their own personal funds—or secure outside financing—to fulfill the buy/sell agreement. This could involve savings, personal loans, or even selling assets.

Pros:

• Does not impact company cash or operations
• Transaction can be completed quickly if funds are readily available
• No dilution of ownership for other partners—ownership remains with the intended parties

Cons:

• Few individuals have sufficient liquid assets for large buyouts
• Personal financial stress and risk, including the potential loss of collateral
• Potential delays if funds must be raised through loans or asset sales

Viability: This method is rarely practical except in cases where the buyout amount is small, or the owners are particularly wealthy.

Example: In a rapidly growing tech startup, three partners agree to buy out a fourth for $600,000. Only one has the necessary savings; the others must seek personal loans, putting their homes at risk as collateral. This creates anxiety and tension, and delays the buyout process, threatening company momentum at a critical stage.

Internal Financing from Business Revenue: Pros, Cons, and Examples

Rather than relying on existing cash, some businesses opt for internal financing—paying the buyout amount gradually from future profits or revenues. This approach spreads the financial burden over months or years.

Pros:

• More accessible for businesses lacking large cash reserves
• Payments can be structured to match business performance and cash flow
• Reduces the need for large upfront payments

Cons:

• Ongoing payment obligations may restrict reinvestment in growth, hiring, or operations
• Uncertainty if business revenues decline, making payments problematic
• Departing owner may remain financially tied to the business until the buyout is complete, potentially causing friction

Viability: This approach is common in privately held companies with predictable earnings, but carries real risk if revenues fluctuate unexpectedly.

Example: A group of veterinarians owns a thriving animal hospital. When one partner retires, the remaining partners agree to pay out $400,000 over five years from profits. If patient volume drops due to a local competitor or an economic downturn, the payments become difficult to sustain, putting pressure on everyone involved and raising doubts about the long-term plan.

Third-Party Funding: Insurance Solutions

Insurance is often viewed as the “secret weapon” of buy/sell agreement funding. With this method, the business or its owners purchase life and disability insurance policies on each owner. Should a triggering event occur, the policy pays out promptly, providing funds for the buyout without depleting either company or personal resources.

Pros:

• Immediate liquidity—cash is available when it’s needed most, often within weeks
• No drain on business cash reserves or personal assets
• Low risk—predictable premiums and guaranteed payout if an event occurs
• Departing owner’s family receives fair value, ensuring financial security

Cons:

• Upfront and ongoing premium costs, which must fit within business budgets
• Requires careful planning and coordination with qualified insurance professionals
• Policies must be maintained—if coverage lapses, the buyout plan can fail

Viability: Insurance funding is particularly suited to closely held businesses, partnerships, and family-owned companies. Policies can be tailored to fit the business’s needs, with premiums calculated to be affordable and sustainable.

Example: A law firm with four partners purchases $1 million life insurance policies on each owner, naming the firm as beneficiary. When one partner tragically passes away, insurance proceeds arrive quickly, funding the buyout painlessly and allowing the firm to move forward without interruption. The partners avoid draining company cash or personal savings, and the deceased partner’s family receives the full, agreed-upon value.

Comparing the Options: What Works Best for Small Businesses?

Let’s recap the key benefits and drawbacks of each approach:

For many small businesses, the right solution often combines several approaches. However, low risk and high availability are usually the best recipe for sustained success. Business cash reserves and buyers’ external cash almost always fall short—insurance-backed buyouts and internal financing may offer the right balance of accessibility and security.

Key Takeaways

Buy/sell agreements are the bedrock of business continuity planning. Without a clear funding strategy, however, even the best agreement can fall apart when it’s needed most. Here’s what every business owner should remember:

• Don’t count on business cash reserves alone—depletion can undermine your company’s health.
• External cash from buyers is seldom available and often risky.
• Internal financing is flexible but exposes everyone to future uncertainties.
• Insurance solutions offer predictable, reliable funding with minimal operational disruption.
• Low risk and high availability are the key to sustained business success—and to peace of mind for everyone involved.

Are you ready to explore which solution, or combination of solutions, could be the right fit to fund your buy/sell agreement? Don’t leave the future of your business to chance. Schedule a free virtual discovery meeting today—let’s design a strategy that fits your unique business, protects your partners, and secures your legacy.

Take action now, and ensure your business’s success for years to come. Your partners, your family, and your future will thank you!