If you co-own a Minnesota business and don’t have a buy-sell agreement, you have a problem you just haven’t felt yet. One partner dies, gets divorced, goes bankrupt, or simply decides to leave—and suddenly you’re negotiating the future of your company under the worst possible conditions, governed by default statutory rules that nobody in the room would have chosen.

A buy-sell agreement is a binding contract between business co-owners that establishes what happens to an ownership interest when someone exits. It answers three questions: When can or must an interest be bought or sold? How will it be valued? And how will the purchase be funded? I draft these agreements for multi-owner companies regularly, and the conversations are always easier when everyone is healthy, cooperative, and thinking clearly. That window doesn’t stay open forever.

What a Buy-Sell Agreement Does

Without a buy-sell agreement, the three questions above get answered by probate courts, default statutes, or litigation. None of those are fast, cheap, or predictable.

Under Minnesota Chapter 322C, the operating agreement can override most default provisions regarding transfer, dissociation, and dissolution. A buy-sell agreement—whether standalone or embedded in the operating agreement—is the mechanism for doing that. It replaces statutory defaults with rules the owners actually chose.

Trigger Events

A well-drafted agreement covers every significant event that could change ownership structure. Each trigger can have different terms—a death buyout funded by insurance operates differently than a voluntary departure paid in installments.

Involuntary triggers:

  • Death of an owner
  • Permanent disability or incapacity
  • Bankruptcy or creditor claims against an owner’s interest
  • Divorce (to prevent a former spouse from becoming a co-owner)
  • Involuntary transfer by operation of law

Voluntary triggers:

  • Retirement or planned departure
  • Voluntary withdrawal from the business
  • Termination of employment (when the owner is also an employee)
  • Desire to sell to a third party (often with a right of first refusal)

Company-level triggers:

  • Removal from management
  • Breach of a non-compete or operating agreement
  • Irreconcilable deadlock between owners

Disability deserves special attention. Death gets most of the focus, but permanent disability is statistically more likely during working years and creates a more complicated situation—a disabled owner may have ongoing financial needs that a lump-sum buyout doesn’t fully address. I’ve seen agreements that meticulously plan for death but say almost nothing about disability. That’s a gap.

The Three Structures: Cross-Purchase, Entity Redemption, and Hybrid

The structural choice has significant legal and tax consequences. For most Minnesota businesses with two to five owners, a hybrid structure gives you the most flexibility. Here’s why—and why the other structures still matter.

Cross-Purchase Agreement

In a cross-purchase, the remaining owners personally buy the departing owner’s interest. Owner A dies; Owners B and C each purchase a portion of A’s interest directly from A’s estate.

The big advantage is the stepped-up tax basis. The surviving owners receive a basis equal to what they paid, which reduces capital gains if they later sell the company. For a two-person business, this is often the cleanest structure—one buyer, one seller, straightforward.

The problem shows up with more owners. In a five-owner business, each owner needs a life insurance policy on every other owner, and the number of policies grows fast. The financial burden can also fall unevenly when owners have unequal interests. Each owner must fund the purchase from personal resources or borrowing.

Entity Redemption Agreement

Here, the company itself buys the departing owner’s interest. The company holds one insurance policy per owner, manages the buyout process, and the remaining owners’ percentage interests increase proportionally without them spending personal funds. Administratively, it’s simpler—especially for companies with more than two or three owners.

But there are two serious drawbacks.

First, the surviving owners get no basis step-up. That can mean significantly higher capital gains tax on a future sale.

Second—and this is the development every Minnesota business owner with an entity redemption agreement needs to understand—the Supreme Court’s 2024 decision in Connelly v. United States changed the math on entity-owned life insurance.

In Connelly, the Court unanimously held that when a corporation owns life insurance to fund a buy-sell redemption, the insurance proceeds are included in the company’s value for estate tax purposes. The deceased owner’s estate owes taxes on the full company value including the insurance, even though those proceeds are earmarked for buying out the deceased owner’s shares. That’s a significant hit.

For C corporations, there’s an additional risk: a redemption that doesn’t qualify under the sale-or-exchange rules may be recharacterized as a dividend, resulting in double taxation.

Hybrid (Wait-and-See) Agreement

A hybrid structure gives the company the first option to redeem the departing owner’s interest, with the remaining owners holding a secondary cross-purchase right if the company doesn’t exercise its option (or vice versa). The owners decide at the time of the trigger event which structure produces the better tax result.

This is the structure I recommend most often. It preserves the cross-purchase option, which can avoid the estate tax inflation Connelly created for entity-owned insurance. The tradeoff is more complex drafting—the agreement must clearly define option periods, decision-making, and fallback provisions—and the selling party won’t know in advance whether the company or the individuals will be the buyer. In my experience, that uncertainty is manageable. The tax flexibility is worth it.

Minnesota-Specific Structural Considerations

Minnesota’s tax treatment affects the structural choice in ways that differ from the federal analysis:

  • No entity-level income tax for LLCs taxed as partnerships or S corporations. This reduces the risk of double taxation on redemptions, making entity redemption more attractive for pass-through entities than for C corporations.
  • Minnesota follows federal treatment on S corporation basis rules. An S corporation redemption doesn’t create the same dividend recharacterization risk as a C corporation redemption, but the basis step-up issue remains.
  • Minnesota estate tax. Minnesota has its own estate tax with a $3 million exemption for 2026—dramatically lower than the federal exemption of approximately $13.99 million. This means the Connelly decision has outsized impact for Minnesota business owners whose estates fall between the state and federal thresholds. If your estate is worth $5 million and your entity-owned life insurance adds another $2 million to the company’s taxable value, you may cross the Minnesota threshold even though you’re well under the federal one.

Valuation: Where Most Disputes Start

A buy-sell agreement is only as good as its valuation mechanism. Get this wrong and the agreement either overcompensates the departing owner at the remaining owners’ expense, or undercompensates them and invites litigation from their estate.

Common Valuation Methods

Fixed price. The owners agree on a specific dollar value, typically updated annually. Simple and certain—when it’s current. The most common buy-sell agreement failure I see is a fixed price that nobody updated. A value set in 2021 for a company that has tripled in revenue is a lawsuit waiting to happen.

Formula-based. The agreement specifies a formula—a multiple of revenue, EBITDA, or book value. This automatically adjusts as the business grows, but formulas can produce results that diverge significantly from true fair market value, particularly for service businesses, asset-heavy companies, or businesses with lumpy revenue.

Independent appraisal. A qualified appraiser determines fair market value at the time of the trigger event. Most accurate, but expensive, time-consuming, and potentially contentious. The agreement should specify whether one appraiser or a panel is used, what standard of value applies, and how disputes are resolved.

Agreed value with appraisal fallback. The owners set a value annually, but if it hasn’t been updated within a specified period (typically 12–24 months), an independent appraisal kicks in. This is my preferred approach for most clients. It combines the simplicity of a fixed price with the safety net of an appraisal—so the owners’ forgetfulness doesn’t become a litigation trigger.

Valuation Discounts and Premiums

For closely held businesses, valuation often involves discounts for lack of marketability (the interest can’t be sold on a public exchange) and lack of control (a minority interest has limited governance power). These discounts can reduce the buyout price by 20–40%.

There’s an inherent tension. The departing owner wants full fair market value. The remaining owners want discounts applied. Resolving this in advance—when everyone is negotiating in good faith—is far better than litigating it after a trigger event.

IRS Scrutiny of Buy-Sell Valuations

The IRS does not automatically accept the valuation in a buy-sell agreement for estate or gift tax purposes. Under IRC § 2703, the IRS can disregard a buy-sell restriction if:

  • It is not a bona fide business arrangement
  • It is a device to transfer property for less than full and adequate consideration
  • Its terms are not comparable to similar arm’s-length arrangements

Buy-sell agreements among family members receive heightened scrutiny. The agreement must reflect genuine business purposes and market-rate terms to withstand challenge.

Funding the Buyout

The best buy-sell agreement in the world is worthless if the buyer can’t pay.

Life Insurance

Life insurance is the most common funding mechanism for death-triggered buyouts. The proceeds provide immediate cash to complete the purchase.

Cross-purchase insurance: Each owner holds a policy on every other owner’s life. When an owner dies, the surviving owners receive the proceeds and use them to buy the deceased owner’s interest.

Entity-owned insurance: The company holds and pays premiums on a policy for each owner. When an owner dies, the company receives the proceeds and uses them to redeem the interest.

After Connelly: If you have entity-owned life insurance funding a buy-sell agreement, you need to review the arrangement with counsel. The Supreme Court’s holding that entity-owned insurance proceeds inflate company value for estate tax purposes may make cross-purchase or hybrid structures more tax-efficient. This isn’t a theoretical concern—for Minnesota business owners near the $3 million state estate tax threshold, the difference can be substantial. One issue I see regularly: the buy-sell agreement assumes a $2 million buyout, but the insurance policy was purchased at $1 million years ago and never updated. That mismatch alone can unravel the entire plan.

Disability Insurance

Disability buyout insurance covers permanent disability. These policies typically have a 12–24 month waiting period before benefits are payable. The buy-sell agreement’s disability trigger must be defined consistently with the insurance policy terms—otherwise you have a right to buy but no money to fund it.

Installment Payments

For voluntary departures—retirement, resignation—installment payments allow the buyer to pay over time, often 3–7 years, with interest. The agreement should specify:

  • The down payment amount
  • The interest rate (or a formula tied to a benchmark rate)
  • The payment schedule
  • Security for the unpaid balance (often a promissory note secured by the purchased interest)
  • Acceleration provisions in the event of default

Sinking Fund and Cash Flow

Some businesses fund buyouts from operating cash flow or build a reserve account over time. These approaches can work for smaller buyouts, but they strain the company if the amount is large relative to cash on hand. A company-funded buyout also reduces working capital during the transition. The practical challenge with sinking funds is that most growing businesses prefer to reinvest cash rather than set it aside.

Coordination with Other Documents

A buy-sell agreement doesn’t operate in isolation. Conflicting provisions across documents are one of the fastest paths to litigation.

Operating agreement or bylaws. The buy-sell agreement’s transfer restrictions must be consistent with the operating agreement (LLC) or bylaws (corporation). Many practitioners—myself included—build buy-sell provisions directly into the operating agreement rather than drafting a separate document. That eliminates the coordination problem entirely.

Estate planning documents. The agreement must coordinate with each owner’s will, trust, and power of attorney. If a trust holds the business interest, the trust must authorize the trustee to comply with the buy-sell terms. An estate plan that conflicts with the buy-sell agreement can delay the buyout and trigger litigation between the company and the deceased owner’s estate.

Employment agreements. If an owner is also an employee, the employment agreement’s termination provisions should align with the buy-sell agreement’s trigger events. Termination of employment is often a trigger, and the buyout terms should account for any severance obligations.

When to Create or Update Your Buy-Sell Agreement

If you don’t have a buy-sell agreement, the time to create one is now—while all owners are healthy, cooperative, and able to negotiate in good faith. Once a trigger event occurs, that window has closed.

If you already have one, review it whenever:

  • Ownership changes. A new partner joins or an existing partner leaves.
  • Company value shifts significantly. Revenue doubles, a major contract is signed, or the company acquires another business.
  • Tax law changes. Connelly v. United States (2024) is exactly the kind of development that should trigger a review. If your agreement relies on entity-owned insurance, the estate tax implications have changed.
  • Personal circumstances change. Marriage, divorce, birth of children, or changes in an owner’s health.
  • Annually. Even without a specific event, an annual review ensures the valuation, insurance coverage, and terms remain current. I tell clients to tie it to their annual insurance review—same meeting, same conversation.

A buy-sell agreement isn’t something you draft once and file away. It’s a living document that protects the business only if it reflects current reality. Using a generic template without customization for Minnesota’s LLC statute, state estate tax thresholds, and your specific ownership dynamics is barely better than having nothing at all.

To discuss a buy-sell agreement for your Minnesota business, contact me at aaronhall.com/contact or call 612-466-0040.