Buy-Sell Agreements for California Businesses

Every business with two or more owners has a buy-sell agreement. Most haven’t written theirs down, so the Corporations Code writes it for them. I draft buy-sell agreements for California LLCs, partnerships, and corporations, and this page covers what goes in one, how the price and the money get settled, and the two technical traps, spousal consent and the life insurance notice rule, that catch owners who used a template.

Do I need a buy-sell agreement in California?

Yes, if more than one person owns the company or you want it to survive you. A buy-sell agreement answers one question in advance: when an owner leaves, who ends up with that owner’s share, and what do they pay for it?

The agreement can be a separate document or a set of articles inside the operating agreement, a partnership agreement, or a shareholders’ agreement. Where it sits matters less than whether the documents agree with each other. A buy-sell clause that conflicts with the operating agreement’s transfer restrictions starts the fight it was supposed to prevent.

People sometimes confuse this with an asset or stock purchase agreement for selling the whole company to an outsider. That’s a different document, covered in my guide to selling a California business.

What happens if my business has no buy-sell agreement?

California’s default rules take over, and they differ sharply by entity type. The LLC rules are the harshest for a departing owner’s family, and the partnership rules are the harshest for the owners who stay.

Event	LLC (no agreement)	General partnership (no agreement)
Owner dies	The member is dissociated, and the estate holds only a right to distributions, with no vote.	The partner is dissociated, and the partnership must buy out the interest.
Owner wants out	The member can withdraw but isn’t entitled to be paid for the interest.	The partner can withdraw, and the partnership must buy the interest unless the withdrawal dissolves it.
Price	No statutory price, because there’s no statutory buyout.	The greater of liquidation value or going-concern value, plus interest.

For an LLC, an individual member is dissociated when the member dies (Corp. Code § 17706.02(f)). After dissociation, any transferable interest the person owned is held solely as a transferee (Corp. Code § 17706.03(a)(3)). Unless the articles or a written operating agreement provide otherwise, a member’s dissociation doesn’t entitle the member to a distribution (Corp. Code § 17704.04(b)).

Put plainly, the family inherits a stake it can’t vote, can’t sell to anyone who wants it, and can’t make the company buy. The surviving members inherit a silent co-owner who is entitled to a share of every distribution they decide to make. Neither side chose that.

A general partnership runs the other way. If a partner is dissociated, the partnership must cause the partner’s interest to be purchased (Corp. Code § 16701(a)). The statutory buyout price uses the greater of the liquidation value or the value of a sale of the entire business as a going concern (Corp. Code § 16701(b)). If no deal is reached within 120 days after a written demand, the partnership must pay its own estimate of the price in cash (Corp. Code § 16701(e)). A partnership that never planned for that payment can be forced to borrow or sell to make it.

A corporation has no general statutory buyout at all. The shares pass to the estate, and the heirs become shareholders with whatever rights the bylaws give them. The one statutory buyout for corporations appears only once a shareholder sues to dissolve the company, discussed in my guide to business divorce and partner buyouts.

Which events should trigger a buyout?

Any event that puts an interest into the hands of someone the other owners didn’t choose, or keeps it with someone who’s no longer contributing. The standard list is longer than most templates carry.

• Death. The most common trigger and the easiest to fund, because life insurance exists for it.
• Disability. Define it. A workable definition ties to an insurer’s determination or to a set number of days unable to work, such as 180 consecutive days, so nobody has to litigate what “disabled” means.
• Retirement or voluntary departure. Say whether the price changes if an owner leaves early, and whether the company can pay over time.
• Divorce. The trigger that protects against a former spouse becoming a co-owner. It needs the spousal consent covered below.
• Bankruptcy or a creditor’s charging order. A charging order lets a creditor collect an owner’s distributions (Corp. Code § 17705.03(a)). The buyout clause lets the company end that arrangement on its own terms.
• Termination of employment or loss of a license. The trigger matters most in a professional corporation, where an owner who loses a license can’t keep holding shares.
• Deadlock. A tie-breaking exit, such as a shotgun clause where one owner names a price and the other must either buy or sell at it.

For each trigger, decide whether the purchase is mandatory or optional. Death usually calls for a mandatory purchase, so the family knows it will be paid. A voluntary departure often calls for an option, so the company isn’t forced to buy when cash is short. A right of first refusal on any outside sale sits alongside all of these.

How is the buyout price set?

By a method the owners pick now, while nobody knows which side of the deal they’ll be on. The four methods below are the ones I see work in small California companies, and many agreements combine two of them.

Method	How it works	Where it fails
Agreed value	The owners sign a certificate of value every year.	Nobody updates it, and a five-year-old number controls.
Formula	A multiple of earnings, revenue, or book value, set in the agreement.	The multiple stops matching the market, or book value ignores goodwill.
Appraisal	One appraiser, or one per side with a third to break the tie.	It takes months and costs real money, but it’s the most defensible.
Hybrid	Agreed value if updated within a set period, appraisal if not.	Rarely fails. I usually recommend it.

Three details decide more money than the method does. The first is the valuation date, usually the date of the triggering event. The second is whether a minority or marketability discount applies, which on a minority interest can cut the price substantially. The third is whether life insurance proceeds count as a company asset, which the Connelly case discussed below made a live question. For how appraisers approach a small company, see my guide on valuing a California small business.

A family business carries one more rule. For federal estate and gift tax, a price set in an agreement is disregarded unless it’s a bona fide business arrangement, isn’t a device to pass property to family for less than full value, and has terms comparable to an arm’s-length deal (IRC § 2703(b)). The regulations treat those tests as met when more than 50 percent of the interests subject to the agreement are owned by people outside the owner’s family (Treas. Reg. § 25.2703-1(b)(3)). A parent and child who fix a low price to shrink the parent’s estate shouldn’t expect the IRS to accept it.

How is the buyout funded: cross-purchase or entity redemption?

The agreement is only as good as the money behind it. The two structures differ in who buys: in a cross-purchase, the surviving owners buy the interest personally, and in an entity redemption, the company buys it back.

Question	Cross-purchase	Entity redemption
Who owns the life insurance?	Each owner owns a policy on each other owner.	The company owns one policy per owner.
Number of policies	Grows fast. Four owners need twelve policies unless a trust or separate LLC holds them.	One per owner.
Premium risk	An owner who stops paying leaves a gap.	The company pays, so the policies stay in force.
Tax basis for the survivors	The buyers get a cost basis in the shares they buy.	The survivors’ basis doesn’t rise, though their percentage does.
Estate tax value after Connelly	Proceeds go to the owners, outside the company.	Proceeds are a company asset that raises the deceased owner’s share value.

What Connelly changed

Two brothers owned a building supply corporation, and the company carried $3.5 million of insurance on each to fund a redemption. The Supreme Court held that the company’s obligation to redeem the deceased brother’s shares at fair market value didn’t offset the insurance proceeds, so the proceeds counted in valuing the shares for estate tax. The IRS figure for the brother’s shares came to about $5.3 million instead of the $3 million the family was paid. The Court noted that a cross-purchase agreement would have kept the proceeds out of the company.

Take a California example. Two owners of an Oxnard HVAC company each own half, the company is worth $2,000,000, and the company owns a $1,000,000 policy on each. When one dies, the company holds $3,000,000 of value at the moment of death. Applying Connelly, the IRS would start from the $3,000,000 figure, which puts the estate’s half near $1,500,000 for estate tax, even though the agreement pays the family $1,000,000.

That gap produces a tax only for an estate over the federal exemption, $15,000,000 per person in 2026. California has no estate tax of its own. Most small-business owners won’t owe anything, but an owner with a valuable company plus real estate and retirement accounts should run the numbers with a CPA before choosing redemption.

Other ways to fund it

• Installment notes. The buyer pays over five to ten years, with interest and a security interest in the purchased interest. Notes are the usual answer for retirement and voluntary departure, where insurance doesn’t pay. See my guide to installment sales.
• Disability buyout insurance. A separate policy that pays a lump sum after a waiting period. The agreement’s disability definition should match the policy’s.
• A sinking fund. Cash the company sets aside. It works for small amounts and rarely for a full buyout.

If you switch from redemption to cross-purchase by moving existing policies, watch the transfer-for-value rule. A policy transferred for value loses part of its income tax exclusion, but the rule doesn’t apply to a transfer to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer (IRC § 101(a)(2)). Notice what’s missing from that list: a co-shareholder. Selling a policy from a corporation to a fellow shareholder of the insured doesn’t fit an exception. Many cross-purchase conversions route the policies through a partnership or LLC.

Why does my spouse need to sign the buy-sell agreement?

Because in California your spouse probably owns part of what the agreement restricts. All property a married person acquires during the marriage while living in California is community property, unless a statute says otherwise (Fam. Code § 760). An LLC interest bought or built during the marriage usually qualifies.

The spouse who runs a business that is all or substantially all community personal property has primary management and control of it (Fam. Code § 1100(d)). That lets the owner-spouse sign the operating agreement. It doesn’t settle what happens to the other spouse’s half at a divorce or a death.

At a divorce, the court divides the community estate equally unless the spouses agree otherwise in writing or by stipulation in open court (Fam. Code § 2550). At the death of a married person, one-half of the community property belongs to the surviving spouse (Prob. Code § 100(a)). A provision for a nonprobate transfer of community property at death, signed by a married person without the spouse’s written consent, isn’t effective as to the nonconsenting spouse’s interest (Prob. Code § 5020).

So a buy-sell agreement signed only by the owners leaves an argument open: the non-owner spouse never agreed to the transfer restrictions, the price, or the forced sale. A spousal consent closes it. In it, the spouse acknowledges reading the agreement, agrees that any community interest the spouse holds is bound by it, and agrees that on a divorce the interest goes to the owner-spouse or is sold under the agreement’s terms. I suggest the spouse have the chance to consult separate counsel before signing. More on the underlying rules is in my guides on spouses owning an LLC and California community property.

What is the IRC § 101(j) notice-and-consent rule?

It’s the federal rule that decides whether life insurance a business owns on an owner or employee pays out tax-free. Miss the paperwork, and the business can owe income tax on most of the death benefit.

For an employer-owned life insurance contract, the income tax exclusion is capped at the premiums the policyholder paid (IRC § 101(j)(1)). The full exclusion comes back only if the notice and consent requirements were met and an exception applies (IRC § 101(j)(2)). Before the policy is issued, the insured must be notified in writing that the policyholder intends to insure the employee’s life and of the maximum face amount, must consent in writing to being insured and to coverage continuing after employment ends, and must be told in writing that the policyholder will be a beneficiary (IRC § 101(j)(4)).

The exceptions are broad enough to cover most owners. They include an insured who was an employee at any time during the 12 months before death, an insured who was a director or highly compensated employee when the policy was issued, and proceeds used to buy an equity interest from the insured’s family or estate (IRC § 101(j)(2)). The word “before” is what trips people up. Consent signed after the policy is issued doesn’t satisfy the rule, and there’s no fix after the fact.

California follows the federal rule. Proceeds of an employer-owned life insurance contract received by a corporation are excluded from California gross income only in accordance with the federal rule for employer-owned contracts (Rev. & Tax. Code § 24305(c)). California’s personal income tax adopts the federal exclusions from gross income unless it says otherwise (Rev. & Tax. Code § 17131). California’s Insurance Code adds its own requirement: an employer that insures a director, officer, or employee must obtain the written consent of the person being insured (Ins. Code § 10110.1(c)).

A company that owns these policies also files an annual information return reporting the number of insured employees, the coverage in force, and whether it has a valid consent for each insured (IRC § 6039I(a)). The IRS form for that report is Form 8925. Premiums on a policy where the company is a beneficiary aren’t deductible (IRC § 264(a)(1)). My key person insurance guide walks through the same rules for a policy that protects the company rather than funding a buyout.

What tax questions should I take to my CPA?

I draft the agreement and explain the legal effect of each structure. The tax modeling belongs with your CPA, and these are the questions I’d bring.

• How does each structure affect the survivors’ basis and their gain on a later sale?
• For a corporation, will a redemption be treated as a sale or as a dividend, given the family attribution rules?
• For an LLC or partnership taxed as a partnership, how should payments to a departing member be characterized, and should the company make a basis adjustment election?
• Is my estate large enough that the Connelly valuation effect matters?
• If the company is an S corporation, does the agreement protect the election against a transfer to an ineligible shareholder?

How does a buy-sell agreement fit with my estate plan?

They should be drafted to match. Most of my clients hold their business interest in a living trust, and the buy-sell agreement has to treat that trust as a permitted owner, name the successor trustee as the person who deals with the buyout, and pay the price to the trust.

Once a trust is the member, a change in trustee doesn’t dissociate it (Corp. Code § 17706.02(h)). That keeps the interest out of probate and lets the successor trustee sign the sale documents promptly. The broader planning, including who runs the company in the meantime, is in my business succession planning guide, the business continuity guide, and the page on what happens to an LLC when the owner dies. An owner who might become incapacitated rather than die also needs a business power of attorney that reaches the company interest.

What are the most common buy-sell mistakes?

1. A fixed price nobody updated. The agreement pays the family a number from years ago.
2. No funding. The agreement obligates a purchase the buyer can’t afford.
3. Policies that lapsed or no longer match the price after the company grew.
4. No spousal consent, which leaves the community interest arguably unbound.
5. Section 101(j) consents signed after the policy issued, or never signed.
6. A disability trigger with no definition.
7. A buy-sell clause that contradicts the operating agreement or the trust.
8. Redemption funding in a company large enough for Connelly to raise estate tax.

Guides in this series

• Partnership agreements in California
• Key person insurance for California small businesses
• How to add a member to an LLC in California
• How to remove a member from an LLC in California
• Business divorce: buying out a partner in California
• Assigning an LLC membership interest in California

Where my role starts and stops

I draft buy-sell agreements, spousal consents, and the operating agreement or shareholder agreement changes that go with them, and I coordinate with your CPA, your insurance agent, and an appraiser when the price calls for one. I don’t sell insurance or recommend a carrier, and I don’t set the value of your company. If the owners are already in a dispute over a buyout, or someone has filed suit, you need litigation counsel, and I can refer you.

Frequently asked questions

How much does a buy-sell agreement cost in California?

Drafting time depends on the number of owners, the entity, and the funding. I bill buy-sell work at my hourly rate, and a two-owner LLC agreement with insurance funding and spousal consents is a far smaller job than a four-owner corporation with installment terms and a trusteed cross-purchase. The appraisal, if you use one, and the insurance premiums are separate costs.

Can a buy-sell agreement be added after the business is formed?

Yes, and most are. Adding one to an LLC usually means amending the operating agreement, which by default takes the consent of every member. Doing it while everyone is healthy and on good terms is the whole point.

Is a buy-sell agreement the same as an operating agreement?

No. The operating agreement governs how the LLC runs, and the buy-sell terms govern what happens to an owner’s interest when that owner leaves. The buy-sell terms are often a section of the operating agreement, but many operating agreements, especially templates, leave them out.

Who should own the life insurance in a buy-sell agreement?

It depends on the number of owners, their ages and health, and the company’s value. Two or three owners often fit a cross-purchase, while a larger group may fit a redemption or a separate entity that holds the policies. After Connelly, an owner with an estate near the federal exemption has a stronger reason to keep the proceeds outside the company.

What happens to a buy-sell agreement in a divorce?

If the non-owner spouse signed a spousal consent, the agreement’s divorce trigger and price usually control how the community interest is handled. Without a consent, the family court divides the community estate, and the other owners may find themselves dealing with a former spouse. A family law attorney handles the divorce itself.

How often should the price in a buy-sell agreement be updated?

At least once a year if you use an agreed value. Many agreements tie the update to the annual meeting or tax filing and fall back to an appraisal if the value is more than a set number of months old.

Does a single-owner business need a buy-sell agreement?

Not with co-owners, but it may need one with a key employee or a competitor who agrees to buy the business at the owner’s death. For a sole owner, the more common tool is a living trust holding the interest plus a written plan for who runs the business, covered in my succession planning guide.