Buy-Sell Agreements: The Exit Plan Every Minnesota Business Owner Needs

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 Minnesota Revised Uniform Limited Liability Company Act), the operating agreement is the primary governing document. It governs relations among the members and between the members and the company, and to the extent the operating agreement does not otherwise provide, the chapter’s default rules govern (Minn. Stat. § 322C.0110, subds. 1-2), subject to the mandatory provisions an operating agreement may not vary (subd. 3). 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.

That override power has limits worth knowing before you rely on it. Minn. Stat. § 322C.0110, subd. 3 lists provisions an operating agreement may not vary. On the topics a buy-sell touches, you cannot contract around a court’s power to decree dissolution when the company’s activities are unlawful or it is not reasonably practicable to carry them on, or when the managers or those in control act illegally, fraudulently, or in a manner that is oppressive to a member (Minn. Stat. § 322C.0701, subd. 1(4)-(5)); nor the requirement to wind up the business. And while an operating agreement may not eliminate the members’ fiduciary duties or their obligation of good faith and fair dealing, it may restrict them if the restriction is not manifestly unreasonable (Minn. Stat. § 322C.0110, subds. 4-7). Dissolution and wind-up are the absolute floor beneath the word “most.”

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 basis. When the surviving owners buy the interest directly, their basis in the newly acquired shares equals what they paid (26 U.S.C. § 1012(a)), which reduces the capital gain, and the tax, if they later sell the company. The precise term is a cost basis under section 1012, not a “stepped-up basis”: the step-up to fair market value at death under section 1014 applies to the decedent’s shares in the estate’s hands, not to the survivors’ newly purchased shares. 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 increase. Because the company, not the owners, buys the departing interest, the survivors purchase nothing and their cost basis in their own shares is unchanged. A later sale of the business can then generate significantly higher capital gains tax.

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, 602 U.S. 257 (2024), changed the math on entity-owned life insurance.

In Connelly, a unanimous Court held that “[a] corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces a corporation’s value for purposes of the federal estate tax,” and that “[l]ife-insurance proceeds payable to a corporation are an asset that increases the corporation’s fair market value.” The practical effect is that the deceased owner’s shares are valued to include the insurance proceeds, even though those proceeds are earmarked for buying out the deceased owner’s shares. The estate owes more tax as a result.

The Court also flagged the fix. The specific choice that drove the tax in Connelly was having the corporation, rather than the individual shareholders, own the policies and receive the proceeds. A cross-purchase agreement, in which the shareholders own policies on each other and receive the proceeds directly, keeps the insurance out of the company and avoids inflating the deceased owner’s taxable estate. Do not overread the holding in the other direction, though: the Court was explicit that it did “not hold that a redemption obligation can never decrease a corporation’s value,” so the result can differ in other circumstances.

For C corporations, there is an additional risk. A redemption is treated as a sale or exchange (generally producing capital gain measured against the shareholder’s basis) only if it satisfies one of the tests in 26 U.S.C. § 302(b): that it is not essentially equivalent to a dividend, that it is substantially disproportionate, or that it is a complete termination of the shareholder’s interest. A redemption that fails all of them is instead “treated as a distribution of property to which section 301 applies” (26 U.S.C. § 302(d)), taxable as a dividend to the extent of the corporation’s earnings and profits. Because the corporation cannot deduct that payment and the shareholder is taxed on the full amount as a dividend, with no recovery of basis, rather than only on gain over basis, the recharacterization produces double taxation. A complete redemption of all of a departing owner’s stock is the clearest way to secure exchange treatment and avoid that result.

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 mandatory entity-level income tax on the ordinary business income of LLCs taxed as partnerships or S corporations. That income generally passes through to the owners rather than being taxed at the entity level, which reduces the risk of double taxation on redemptions and makes entity redemption more attractive for pass-through entities than for C corporations. One qualification matters: “no entity-level tax” is not literally true. An S corporation remains subject to specified Minnesota entity-level taxes, including the minimum fee imposed on both S corporations and partnerships based on Minnesota property, payroll, and sales (Minn. Stat. § 290.0922, subd. 1), and income taxes on recognized built-in gains (Minn. Stat. § 290.9727) and on excess net passive investment income (Minn. Stat. § 290.9729). By statute, an S corporation “shall not be subject to the taxes imposed by this chapter, except” those enumerated (Minn. Stat. § 290.9725).
• Minnesota conforms to federal S corporation treatment. Minnesota recognizes any entity with a valid federal S election and computes the S corporation shareholders’ income under provisions tied to federal taxable income (Minn. Stat. §§ 290.9725, 290.9726). An S corporation redemption does not create the same dividend recharacterization risk as a C corporation redemption: an S corporation with no accumulated earnings and profits applies the return-of-basis rules of 26 U.S.C. § 1368(b), so a distribution is generally a tax-free return of basis (then capital gain) rather than a dividend. The exception is an S corporation carrying accumulated earnings and profits from prior C corporation years, where a distribution can still be recharacterized as a dividend under the three-tier ordering of 26 U.S.C. § 1368(c) (adjustments account first, then dividend to the extent of accumulated earnings and profits, then return of basis). The basis point is unchanged either way: a redemption gives the remaining owners no basis increase, unlike a cross-purchase.
• Minnesota estate tax. Minnesota imposes its own estate tax with a $3 million exemption for decedents dying in 2020 and later, including 2026 (Minn. Stat. § 291.016, subd. 3(b)). That figure is a flat statutory amount, not indexed to inflation, so it stays at $3 million until the Legislature changes it. It sits dramatically below the federal exemption, which for deaths in 2026 is $15 million per person under 26 U.S.C. § 2010(c)(3), as amended by the One Big Beautiful Bill Act (Pub. L. No. 119-21, § 70106, signed July 4, 2025). That Act raised the amount from the roughly $13.99 million 2025 level, made the higher exemption permanent (it no longer sunsets), and indexes it for inflation only for deaths in years after 2026, so the federal figure will keep rising above $15 million. The same Minnesota subdivision allows a separate subtraction for qualified small business property and qualified farm property, which can let a qualifying estate shield up to a combined $5 million (Minn. Stat. § 291.016, subd. 3(a)): directly relevant if your business pushes you against the $3 million ceiling. The wide gap between the state and federal thresholds is why the Connelly decision has outsized impact for Minnesota business owners. 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). Whether those discounts apply, and how large they are, depends on the governing valuation standard: there is no fixed 20 to 40 percent rule. Where fair market value controls, such as an estate or gift-tax appraisal or a buy-sell keyed to fair market value, appraisers commonly apply marketability and control discounts that can materially reduce value. But in a Minnesota court-ordered buyout of a minority owner under Minn. Stat. § 302A.751, the statute sets the price at the shares’ fair value, which the Minnesota Supreme Court has defined as the owner’s pro rata share of the company’s value as a going concern. Whether a marketability discount applies to that figure is a fact-specific fairness determination, not a categorical rule: the court declined to adopt a bright-line rule and has applied such a discount only in extraordinary circumstances, to reach a result fair and equitable to all parties (Advanced Communication Design, Inc. v. Follett, 615 N.W.2d 285 (Minn. 2000)).

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. One more reason to draft the price yourself: under the same statute, if the owners already have a buy-sell agreement, a court will order the sale “for the price and on the terms set forth in” it unless it finds them unreasonable under all the circumstances (Minn. Stat. § 302A.751, subd. 2). Your negotiated price generally governs; the statutory fair-value standard is only the fallback.

One scope caveat matters here. Both section 302A.751 and Advanced Communication Design are corporate-law authorities: they govern Minnesota business corporations under Chapter 302A, not LLCs. The LLC statute has no equivalent buy-sell-honoring rule. Under Minn. Stat. § 322C.0701, subd. 2, a court that finds grounds for dissolution may instead “order a remedy other than dissolution, which may include the sale for fair value of all membership interests,” but the LLC statute contains no counterpart provision requiring the court to honor the price and terms of an existing buy-sell agreement. That makes a carefully drafted operating-agreement buy-sell even more important for LLC owners: the statutory backstop that protects a negotiated corporate buy-sell price is weaker here, so the operating agreement itself has to do that work.

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 26 U.S.C. § 2703(a), the value of property is determined “without regard to” any option, agreement, or right to acquire it at less than fair market value, or any restriction on the right to sell it. Put plainly, the buy-sell price is ignored and the interest is valued at full fair market value, unless the agreement clears the safe harbor in section 2703(b).

That safe harbor is a conjunctive test. The restriction is respected only if it meets each of three requirements:

• It is a bona fide business arrangement.
• It is not a device to transfer property to the decedent’s family for less than full and adequate consideration.
• Its terms are comparable to similar arrangements entered into by persons in an arm’s-length transaction.

Failing any single one of the three is enough for the IRS to disregard the restriction and value the interest at full fair market value.

Buy-sell agreements among family members face particular scrutiny, because the section 2703(b) safe harbor requires that the restriction not be a device to transfer property to the decedent’s family for less than full and adequate consideration. A family-controlled 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 increase 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.

Related Articles

• What Happens to Your Business If Something Happens to You?
• Removing a Business Officer Who Won’t Step Down: Legal Options in Minnesota
• Learn more about Business Formation & Governance