7 Signs a Buy-Sell Agreement May Be Underfunded

When a triggering event occurs, the remaining owners or the company may be obligated to buy an interest at a price set by the agreement. If funding falls short, the gap is typically covered by company cash, new debt, or installment payments to a departing owner or a family — each of which puts strain on the business at a difficult moment.

For attorneys and CPAs, an underfunded agreement is one of the most common sources of post-event disputes between surviving owners and an owner's estate.

The purchase price is the starting point for a funding discussion. A value agreed to when the company was smaller may no longer bear much relationship to what an ownership interest would cost today. Revenue growth, stronger margins, acquisitions, new debt, and the loss of a major customer can all change the picture. Growth is not the only reason to review value; a decline can also leave the agreement and the insurance out of alignment.

Ask when the owners last followed the agreement’s valuation procedure, not just when they last discussed what the business might be worth. An informal estimate can help identify a potential gap, but it is not a formal appraisal or a substitute for the price mechanism in the agreement. The attorney and a qualified valuation professional should help resolve those distinctions.

A policy’s death benefit usually does not increase simply because the company becomes more valuable. Compare current coverage with the estimated purchase obligation for each owner, rather than comparing total insurance with total company value. A policy that looks substantial on its own can still cover only a fraction of the relevant interest.

Confirm that the coverage is actually in force. Review current statements, premiums, guarantees, term expiration dates, and any policy loans with the insurance professional. An old application or original illustration is not evidence that the same benefit remains available today. Additional coverage may involve underwriting, so discovering a shortfall early creates more options.

A transfer from one owner to another can change two purchase obligations at once. If an owner moves from 25% to 40%, the amount needed to purchase that interest may rise even if the company’s overall value stays constant. Coverage on the other owners may also need to be reconsidered. Equal policies do not necessarily fund unequal interests.

Reconcile the current ownership records with the agreement and the insurance schedule. Include interests held through trusts or other entities in the discussion with counsel. The useful question is whether the money reaches the party responsible for purchasing the actual interest that exists now.

Adding an owner is more than adding a name to a document. The new owner may create additional purchase obligations, require new policies, or change how existing owners share the cost of a cross-purchase buyout. The agreement may require participation, but the necessary coverage or alternative funding can remain unfinished after the ownership transaction closes.

Check whether the new owner signed the required documents, whether coverage was issued rather than merely requested, and whether premiums and beneficiary designations were completed. Where insurance is unavailable, identify the alternative explicitly. An intention to arrange funding later should not be treated as money already available.

Life insurance can address a death-related purchase, but it generally does not provide the same funding for retirement, voluntary departure, or a disability buyout. Some policies have additional benefits, but availability and conditions depend on the contract; they should not be assumed to cover every trigger in a buy-sell agreement.

Work through the events separately. Retirement may require planned reserves or a staged transaction. Disability may call for specialized coverage, cash, or financing. Installments may be workable, but only if their timing and size fit the business’s cash flow. A fully insured death obligation can coexist with a completely unfunded retirement obligation.

The policy owner, insured person, and beneficiary serve different roles. In a typical cross-purchase arrangement, the purchasing owners receive the proceeds needed to buy the deceased owner’s interest. In a typical entity-purchase arrangement, the company receives the proceeds and makes the redemption. Actual arrangements can be more complex, so the documents should be checked together.

If proceeds arrive somewhere other than where the purchase obligation sits, moving the money may require additional transactions with legal and tax consequences. Do not change ownership or beneficiaries casually to fix an apparent mismatch. Have the attorney, CPA, and insurance professional evaluate the proposed correction before it is made.

A useful test is to ask each owner what would happen if a purchase were required tomorrow. Who buys the interest? How is the price determined? When is payment due? What money is available? If the answers depend on several people making assumptions about one another’s work, the plan may have a coordination gap even before a dollar shortfall is measured.

Bring the agreement, ownership information, recent financial statements, and current policy details into one discussion. Document what is known, what requires professional confirmation, and who will handle each unresolved item. The goal is not to promise that every risk disappears; it is to identify whether the financial plan can support the agreement under realistic circumstances.