Buy-Sell Agreements for Michigan Business Owners: What Yours Should Cover

When two or three people own a business together, they usually spend a lot of time deciding how to start it and very little deciding how one of them will leave. Sooner or later someone does leave. An owner dies, becomes disabled, retires, gets divorced, or simply wants out. A buy-sell agreement settles in advance who buys that owner’s interest, at what price, and with what money.

This post walks through the decisions a Michigan buy-sell agreement should make and the mistakes that make one fail when it is finally needed.

What Happens Without a Buy-Sell Agreement?

If your LLC has no agreement on the subject, Michigan’s statutory defaults take over, and they rarely match what owners expect. A member generally cannot withdraw unless the operating agreement allows it (MCL 450.4509). An owner’s interest is generally assignable, but the person who receives it, called an assignee, ordinarily gets only the right to distributions, not voting or management rights (MCL 450.4505). Unless the operating agreement provides another path, an assignee in a multi-member LLC becomes a member only upon a unanimous vote of the members entitled to vote (MCL 450.4506). We explain these rules in more detail in our posts on Michigan LLC operating agreements and what happens to an LLC when an owner dies.

The result can leave the surviving owners managing the company while the deceased owner’s estate or heirs hold only economic rights, rights that may be difficult to sell and that do not, by themselves, create a right to manage the company or force a buyout. Disputes among the owners who remain can end in litigation. Michigan law lets a member sue over illegal, fraudulent, or willfully unfair and oppressive conduct by those in control, and ordering a purchase of the member’s interest at fair value is one of the remedies a court may choose (MCL 450.4515). A buy-sell agreement lets the owners make these decisions themselves, while everyone is still on good terms.

Which Events Should Trigger a Buyout?

The agreement should list the events that start the process and say, for each one, whether a buyout is mandatory or optional. Common triggers include:

• death of an owner;
• disability, with a clear definition and waiting period, so no one argues later about whether it happened;
• retirement or the end of an owner’s employment with the business;
• divorce, where a spouse could otherwise end up with an interest in the company;
• an owner’s bankruptcy or an attempt by a creditor to reach the owner’s interest;
• an owner’s wish to sell to an outsider, often handled with a right of first refusal, which gives the other owners or the company the first chance to buy; and
• deadlock, where the owners cannot agree on a fundamental decision.

Different triggers often call for different terms. Many agreements pay full value on death or disability but a reduced price, or a longer payout, when an owner leaves voluntarily or is terminated for cause. Whatever the owners decide, the agreement should say it plainly.

Redemption Versus Cross-Purchase

There are two basic structures. In a redemption agreement, the company itself buys the departing owner’s interest. In a cross-purchase agreement, the remaining owners buy it personally. Some agreements combine the two, giving the owners the first option and requiring the company to buy if they decline.

A redemption agreement is simpler to administer, especially with several owners, because the company handles the purchase and any insurance. A cross-purchase agreement puts the purchased interest directly in the surviving owners’ hands, but it requires each owner to have the means to buy, and if insurance is used, each owner may need a policy on every other owner. The choice also has tax and valuation consequences, which is where a 2024 U.S. Supreme Court decision comes in.

How Should the Business Be Valued?

Price is often where buy-sell disputes start. Agreements typically use one of three methods:

• A fixed price that the owners agree on and update periodically, often once a year. It is simple, but it only works if someone actually updates it. A price set ten years ago and never revisited can badly overpay or underpay a departing owner or the owner’s family.
• A formula, such as a multiple of earnings or book value. A formula updates itself, but it can produce a number that no longer reflects what the business is worth if the business changes.
• An independent appraisal at the time of the triggering event. This usually produces the most current number, but it costs money and takes time. The agreement should say who chooses the appraiser, what standard of value applies (for example, fair market value), whether the price may be discounted because the departing owner holds a minority interest without control, and what happens if the owners’ appraisers disagree.

Whichever method the owners choose, the agreement should define the valuation date and leave as little as possible open to argument.

How Will the Buyout Be Funded?

An agreement that obligates someone to buy an interest the buyer cannot afford is not much of a plan. The usual funding sources are:

• Life insurance, which provides cash at exactly the moment a death triggers the buyout.
• Disability buyout insurance, for agreements that treat disability as a trigger.
• Installment payments over a period of years, typically with interest and some security for the unpaid balance.
• Company cash reserves or financing.

Many agreements combine these, using insurance for death and installment payments for other triggers.

What Connelly Changed

In Connelly v. United States (2024), two brothers owned a building supply corporation. Their agreement gave the surviving brother the option to buy a deceased brother’s shares and required the company to redeem them if he declined. The company bought life insurance on each brother to fund that obligation. When one brother died, the company used the insurance proceeds to redeem his shares.

The question was how to value the deceased brother’s shares for federal estate tax. The estate argued that the company’s obligation to redeem the shares offset the insurance proceeds the company received. A unanimous Supreme Court disagreed. The Court held that the company’s obligation to redeem the shares at fair market value did not offset the company-owned life insurance proceeds when the shares were valued for estate tax purposes. The proceeds counted as a company asset, which raised the value of the deceased brother’s shares and increased the estate tax the estate owed. The Court did not hold that a redemption obligation can never reduce a company’s value; it expressly left open situations in which satisfying the obligation would impair the company’s earning capacity, such as having to sell operating assets to pay for the shares.

The estate warned that this rule would make succession planning harder, because a company would need more insurance to fund a fair-market-value redemption. The Court responded: “True enough, but that is simply a consequence of how the Connelly brothers chose to structure their agreement.” It noted that the brothers could have used a cross-purchase agreement, in which each brother owned insurance on the other and the proceeds went to the surviving brother rather than to the company, while acknowledging that every structure has drawbacks. The Court also observed that the price set in a buy-sell agreement is not automatically controlling for estate tax purposes.

Connelly matters most for businesses whose owners have estates large enough to be subject to federal estate tax. But the broader point applies to everyone: how a buyout is structured and funded has consequences beyond the buyout itself, and those choices should be made with tax advice, not left to default.

Making the Agreement Enforceable

A buy-sell agreement is only useful if it is binding on the right people and actually followed. For an LLC, the buy-sell terms usually belong in the operating agreement itself, or in a separate agreement that the operating agreement expressly incorporates, so they override the statutory defaults described above.

For a corporation, Michigan law permits shareholders to agree to transfer restrictions, including rights of first refusal, mandatory purchase obligations, and consent requirements (MCL 450.1473). But a restriction binds a later holder, such as an heir or a buyer, only if it is noted conspicuously on the share certificate or on the information statement used for shares issued without certificates, or if that person actually knows of it (MCL 450.1472). Corporations with buy-sell agreements should confirm that the restriction is noted conspicuously on each share certificate, or on the required information statement for uncertificated shares.

Finally, the owners have to follow their own procedures. Our post on Turner v. J & J Slavik, a Michigan shareholder oppression case, describes a redemption agreement that did not work as intended because the required steps were never completed. Notices, deadlines, appraisals, and closing mechanics should be clear enough that the parties can carry them out years later, possibly with a grieving family on the other side of the table.

When to Review the Agreement

The best time is when the business is formed or when a new owner comes in, because every owner is equally uncertain about who will leave first. After that, the agreement should be reviewed whenever something significant changes: a new owner, a large change in the value of the business, a divorce, a new loan whose terms limit payouts to owners, or the purchase or cancellation of insurance. An agreement that has sat untouched for a decade may describe a business that no longer exists.

Frequently Asked Questions

Should the company or the other owners buy out a departing owner?

It depends on the number of owners, how the buyout will be funded, and the tax consequences, so the choice should be made with legal and tax advice. Owners who fund a company redemption with company-owned life insurance should review the estate tax effect of Connelly v. United States (2024).

How often should a buy-sell price be updated?

If the agreement uses a fixed price, the owners should update it on a regular schedule, often annually, and the agreement should say what happens if they miss an update. A formula or appraisal method avoids a stale number but brings its own tradeoffs in accuracy, cost, and delay.

Does a Michigan LLC need a separate buy-sell agreement?

Not necessarily. Buy-sell terms can be included in the operating agreement or in a separate agreement that the operating agreement incorporates. What matters is that the terms address the statutory defaults on withdrawal and transfer under MCL 450.4505, 450.4506, and 450.4509.

Do corporations need to do anything extra to make a buy-sell agreement binding?

Yes. Under MCL 450.1472, a transfer restriction binds a later holder of the shares only if it is noted conspicuously on the share certificate or on the information statement for uncertificated shares, unless that person actually knows of the restriction.

Related reading: how an LLC lawyer can help with operating and buy-sell agreements, choosing between an LLC, S corporation, and C corporation, what to know before signing a personal guaranty, and working with a Grand Blanc business lawyer.

Please note: This article is provided for general educational and informational purposes only and does not constitute legal or tax advice. Reading it does not create an attorney-client relationship between you and the Law Offices of Maynard F. Newman, P.L.L.C. The law may change, and the right structure depends on the specific business, owners, and documents; confirm the current law and consult qualified legal and tax advisors before acting. This content may also be considered attorney advertising.