Buying out a co-owner: the trigger, the number, and the note that pays for it

Almost every buyout starts as a conversation and becomes a document six weeks later. In between, both sides read the founding paperwork properly for the first time and find it says very little about this. What happens next depends on which default rules apply.

What the law hands you when the documents are silent

The gap between entity types is wider than owners expect, and it runs opposite to the assumption that an LLC is the more protective structure. Under the Revised Uniform Partnership Act — California's version is Corporations Code § 16701 — a partner who dissociates from a general partnership is entitled to be bought out at the greater of liquidation value or going-concern value. The firm must tender an estimate, and where nothing is agreed within 120 days of a written demand it must pay that estimate in cash. A real statutory exit.

An LLC member usually has no such thing. Delaware's Limited Liability Company Act, § 18-603, says a member may resign only at the time or on the events specified in the LLC agreement, and that absent such a provision may not resign before dissolution. Section 18-604 promises fair value on resignation — but only once resignation is possible at all. States word this differently, so check your formation state. A minority shareholder in a private corporation sits in the same place: absent a contract, nobody has to buy.

So the clause belongs in the operating agreement or the shareholder agreement at formation. In a partnership agreement you are instead overriding a default that already works, which is a different drafting job — the rules you get by default sets out what you would be replacing.

Five triggers, and the two nobody writes down

A buy-sell clause lists the events that turn an ownership interest into a transaction. Three are on every checklist. Two blow companies apart.

• Death. The standard trigger, and the one insurance usually funds. Without it the shares pass to an estate, and the survivor is in business with a spouse or three heirs.
• Disability. Needs a definition, a waiting period and a named decider. "Unable to perform their duties", with nobody appointed to decide, is how a trigger becomes a lawsuit.
• Voluntary departure or termination. Where good-leaver and bad-leaver pricing lives, and where the clause must match the employment agreement rather than contradict it.
• Divorce. Frequently missing. A marital settlement can hand shares to somebody who has never worked there. The fix is a compulsory offer back to the company on any such transfer.
• Bankruptcy, charging order or judgment creditor. Also missing. A creditor of one owner should not become an owner. Dull, cheap, and sometimes the only thing keeping a stranger off the register.

Deadlock deserves its own sentence. A 50/50 company with no tiebreak is a standoff with a bank account, and the court remedies are slow, public and expensive. A deadlock trigger — a shotgun offer, a mandated appraisal, an independent chair with a casting vote — turns it into a transaction while the business is still worth something.

Fix the method, not the price

The commonest defect in an existing buy-sell clause is a fixed figure meant to be reviewed annually and reviewed once. The second commonest is no method at all. Both end the same way: the number is negotiated when the two sides want opposite answers.

Redemption or cross-purchase: who signs the cheque

Two structures, not interchangeable. In a redemption the company buys the departing owner's interest and cancels it: the survivors pay nothing personally and their percentages rise automatically. In a cross-purchase they buy it themselves, in agreed proportions, with their own money.

Three consequences follow. Basis: a cross-purchase buyer takes cost basis in what they bought; a redemption gives the survivors no such increase. Characterisation: a corporate redemption is a sale or exchange only within a category in IRC § 302 — most obviously a complete termination of the shareholder's interest. A partial redemption leaving the seller with shares can be taxed as a dividend. Capacity, usually missed: Delaware General Corporation Law § 160 bars a corporation from redeeming its own shares when capital is impaired, or where the purchase would impair it. Without surplus, a company cannot lawfully fund its own buyout.

Where life insurance funds the deal, the edge is sharper. In Connelly v. United States (2024) the Supreme Court held unanimously that a corporation's obligation to redeem a deceased shareholder's stock at fair market value is not a liability offsetting the insurance proceeds held to fund it. The proceeds counted as a company asset, the obligation did not reduce the value, and the estate was taxed on more than it was paid. A cross-purchase avoids that. If the funding sits inside the company, take advice.

The buyer usually cannot pay, so the seller lends

Small buyouts are rarely cash at closing. The usual structure is a deposit plus a promissory note for the balance over several years. That makes the departing owner an unsecured lender to a business they no longer control or see the numbers for.

Two tax mechanics attach to the note. Payments received after the year of sale go under the installment method by default, on Form 6252, unless the seller elects out — IRS Publication 537 sets out how. And the note must carry adequate stated interest; where it does not, part of each payment is recharacterised as interest anyway, tested against the applicable federal rates the IRS publishes monthly. Interest-free seller financing is a reclassification waiting to happen. Promissory note or loan agreement covers which instrument fits.

The release nobody remembers until the bank calls

Expect the lender to refuse, or to want something for it — a replacement guarantee, a paydown, extra security. That takes weeks, and must start before the closing date is set. Where no release can be had, price it: hold back consideration until the facility is repaid.

What closing actually consists of

The board consent is not a formality: it records that the buyout was authorised and, for a redemption, that solvency was considered — board resolutions covers what it must contain.

The useful work on a buyout happens years before anyone needs one. A formula agreed at formation is cheap precisely because neither owner knows which side of it they will stand on; the same formula proposed mid-argument often outlasts the business it was meant to save. If someone has already announced they are leaving, that clause is gone — but the note, the security and the guarantee releases are not, and those decide whether the money arrives.