What is a buy-sell agreement and do you need one in Texas?

What does a buy-sell agreement actually do?

A buy-sell agreement, sometimes called a business continuation agreement, serves two connected functions. It creates an obligation on the surviving or continuing owners to purchase a departing owner's interest, and it creates a matching obligation on the departing owner (or their estate) to sell on the agreed terms.

Without that mutual obligation, a deceased owner's interest passes to their heirs under the will or intestacy rules. Those heirs then become co-owners of the business, regardless of whether they have any relationship with the remaining owners, any ability to contribute to operations, or any intention to stay involved. The surviving owners cannot simply remove them.

A well-drafted buy-sell agreement prevents that outcome by establishing in advance exactly what happens to the ownership interest and at what price.

What are the main types of buy-sell agreements in Texas?

Texas business owners use three common structures, each with different mechanics and tax considerations.

Cross-purchase agreement: Each owner agrees to buy a proportionate share of the departing owner's interest. Works well for smaller ownership groups. Each owner carries life insurance on the others as the funding mechanism. Redemption agreement (entity purchase): The business entity agrees to buy back the departing owner's interest. Simpler to administer with multiple owners because only one insurance policy per owner is needed at the entity level. Hybrid (wait-and-see) agreement: Gives the entity and the surviving owners the option, rather than the obligation, to purchase. The decision is made at the time of the triggering event, which allows flexibility but requires clear decision-making protocols.

What triggering events should a Texas buy-sell agreement cover?

A buy-sell agreement that only covers death addresses a fraction of the situations that actually force ownership transfers. A thorough agreement addresses the following triggering events.

1. Death. The most commonly anticipated trigger. Life insurance on each owner is the standard funding mechanism, with the policy proceeds used to purchase the interest from the estate at the pre-agreed price.
2. Disability or incapacity. A permanent disability that prevents an owner from contributing to the business is economically similar to a death event. The agreement should define what level of disability triggers the buyout and how the purchase is funded, since disability insurance operates differently from life insurance.
3. Voluntary withdrawal or retirement. An owner who wants to exit the business on their own terms should have a mechanism for doing so at a fair price, rather than remaining a minority owner indefinitely with no market for their interest.
4. Divorce. A divorcing owner's spouse may be awarded a portion of the business interest in the property division. The buy-sell agreement can require that the interest be sold back to the company or the remaining owners, rather than transferring to a stranger.
5. Bankruptcy or creditor claims. A creditor who obtains a judgment against an owner may be able to reach that owner's business interest. The agreement can establish a right of first refusal that keeps the interest within the ownership group.

How is the purchase price determined in a Texas buy-sell agreement?

The pricing mechanism is one of the most negotiated points in any buy-sell agreement, and one of the most consequential. Three approaches are commonly used.

A fixed price sets a specific dollar amount in the agreement. This is the simplest approach but requires regular updates to reflect changes in business value. A fixed price that has not been updated in five years can significantly undervalue or overvalue the interest at the time of a triggering event.

A formula price calculates value based on a predetermined metric, such as a multiple of earnings or book value. The formula should be drafted carefully to reflect how the business actually generates value, since a generic multiple may not fit every type of business.

An appraisal process calls for an independent valuation at the time of the triggering event. This avoids stale numbers but introduces delay and potential disagreement over the appraisal itself. Some agreements use an appraisal only as a fallback if the parties cannot agree on the price.

The pricing method also affects life insurance planning. An accurate and current valuation helps ensure that the insurance coverage is sufficient to fund the buyout without requiring the business or remaining owners to come up with cash out of pocket.

When to speak with a Houston attorney about a buy-sell agreement

This article provides general information only and does not constitute legal advice. The right buy-sell structure depends on the number of owners, the entity type, the nature of the business, how it is valued, and the owners' individual estate planning goals. A buy-sell agreement that fits one company may be wrong for another.

The estate planning attorneys at Edison Legal work with Houston-area business owners on buy-sell agreements as part of a coordinated business and personal estate plan. Request a planning consultation to discuss the specifics of your situation.