Exit PlanningBy Maya C.February 24, 2025Updated September 19, 2026

Exit Planning for Partnerships: Buy-Sell Agreements, Funding and Buyouts

Leaving a partnership or multi-owner LLC: what a buy-sell agreement has to settle, what Connelly changed about funding it, and how buyouts get financed.

Exit planning for partnerships comes down to one document and two questions it has to answer: what triggers a buyout, and where the money comes from. The document is the buy-sell agreement, and the most consequential recent development in that area is a Supreme Court decision. In Connelly v. United States, 602 U.S. 257, decided June 6, 2024, a unanimous Court held that a corporation’s obligation to redeem a deceased owner’s shares did not reduce the company’s value for federal estate tax, so the life insurance the company held to fund that redemption counted as a corporate asset.

The short version: write the price mechanism and the funding mechanism into the agreement while everyone still agrees, have the valuation prepared by someone whose credential a lender will accept, and take the structure itself to a tax attorney, because Connelly turned on how the agreement was written.

This page states rules and names the body that publishes each one. It is not tax or legal advice about your partnership, and the structures below have consequences that depend entirely on your own facts.

What a buy-sell agreement has to settle

A buy-sell agreement is the contract among co-owners that governs what happens to an ownership interest when one of them leaves. Everything else in a partnership exit follows from it. At minimum it has to decide five things:

The triggers. Death, disability, retirement, voluntary departure, a divorce or bankruptcy that would otherwise move an interest to an outsider, and a breach or removal.
Who may buy. The remaining owners, the entity itself, or both in a stated order.
How the price is set. A fixed figure updated on a schedule, a formula, or an independent appraisal on a stated standard of value. This is the clause arguments start over, and it is covered in its own section below.
How the purchase is funded. Cash, company-owned or cross-owned life insurance, a note from the buyer, outside borrowing, or a combination.
The terms of payment. Down payment, interest rate, term, security, and what happens if the buyer defaults.

Two structures cover most agreements. In a redemption, the entity buys the departing owner’s interest and the remaining owners’ percentages rise automatically. In a cross-purchase, the remaining owners buy the interest personally. They look similar from the departing owner’s side and behave very differently everywhere else, which is the point Connelly made.

Connelly v. United States, and what it decided about redemptions

Connelly, as executor of the Estate of Connelly v. United States, No. 23-146, 602 U.S. 257, was argued March 27, 2024 and decided June 6, 2024. Justice Thomas delivered the opinion for a unanimous Court, affirming the Eighth Circuit.

The facts, from the syllabus: two brothers were the sole shareholders of a small building-supply corporation. Their agreement gave the surviving brother an option to buy the deceased brother’s shares, and if he declined, “Crown itself would be required to redeem (i.e., purchase) the shares.” The company held $3.5 million of life insurance on each brother to fund that obligation. The estate valued the shares at $3 million, leaving the insurance proceeds out on the theory that the redemption obligation offset them. The IRS added $3 million of proceeds back to the value of the company and assessed $889,914 more in estate tax.

The Court held:

“A corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces a corporation’s value for purposes of the federal estate tax.”

Its reasoning:

“Because a fair-market-value redemption has no effect on any shareholder’s economic interest, no hypothetical buyer purchasing Michael’s shares would have treated Crown’s obligation to redeem Michael’s shares at fair market value as a factor that reduced the value of those shares.”

And, on the argument that the outcome would complicate succession planning for closely held corporations, the Court wrote that “the result here is simply a consequence of how the Connelly brothers chose to structure their agreement.”

That last sentence is the one to act on. The holding is about estate tax valuation where a corporation is obliged to redeem shares it has insured. It does not tell any particular owner to restructure anything, and nobody should read a restructuring instruction into it from a web page. What it does mean is that an agreement drafted before June 2024, funded by company-owned insurance, was drafted against a rule the Supreme Court has since rejected, and that is a reason to have the document read by your own counsel rather than a reason to panic.

Valuation clauses: what the shares are worth, and who gets to say

A valuation clause that names a fixed price and is never updated is the most common way a buy-sell agreement stops working. The alternatives are a formula, or an independent appraisal on stated terms. If the agreement calls for an appraisal, it should also say what standard of value applies, who selects the appraiser, and what the deliverable is, because the word “valuation” covers two very different engagements.

The National Association of Certified Valuators and Analysts draws that line in its Professional Standards, effective for engagements accepted on or after June 1, 2023. A Valuation Engagement applies whichever approaches and methods the credential holder judges appropriate and “results in a Conclusion of Value.” A Calculation Engagement occurs “when the client and member/credentialed designee agree to specific valuation approaches, methods, and the extent of selected procedures and results in a Calculated Value.” A calculated value has to be reported in a Calculation Report carrying a legend that begins “This Calculation Engagement did not include all the procedures required for a Conclusion of Value.” The cheaper engagement is allowed to exist; it just has to say on its face what it is.

NACVA is equally direct about industry multiples: “Rules of thumb are acceptable as reasonableness checks, but should not be used as a stand-alone method.” A buy-sell formula written as a multiple of earnings is a rule of thumb with a signature on it.

On method, the Internal Revenue Manual’s Business Valuation Guidelines state that “the three generally accepted valuation approaches are the asset-based approach, the market approach and the income approach” (IRM 4.48.4.2.3). IRS Publication 561 (rev. December 2025) puts the standard plainly for a closely held business: its fair market value “is the amount that a willing buyer would pay for the interest to a willing seller after consideration of all relevant factors.” Our guide to how to value a small business works through the approaches in detail.

The credentials a lender will accept

If a buyout is going to be financed by an SBA 7(a) loan, the credential on the valuation stops being a matter of preference. SBA SOP 50 10 8.1, effective October 1, 2026, defines a Qualified Source as an individual who “regularly receives compensation for business valuations and is accredited by one of the following recognized organizations and is independent of the loan production function, not involved in the approval of the transaction, and must not have the appearance of a conflict of interest,” and names five accreditations:

ASA, Accredited Senior Appraiser, American Society of Appraisers
CBA, Certified Business Appraiser, Institute of Business Appraisers
ABV, Accredited in Business Valuation, AICPA
CVA, Certified Valuation Analyst, NACVA
BCA, Business Certified Appraiser, International Society of Business Appraisers

One footnote on that list: the CBA is no longer being issued. NACVA’s page on the Institute of Business Appraisers states that NACVA acquired the IBA’s assets in 2008 and that in 2016 it suspended its activities relating to the CBA and MCBA designations and dissolved the nonprofit, with the credentialing program ceased and existing holders supported under NACVA’s oversight. Someone holding a CBA today earned it before 2016.

The same SOP adds requirements that catch people out. The valuation “must be requested by and prepared for the Lender,” and the lender “may not use a business valuation prepared for the Applicant or the seller,” so a valuation the departing partner commissioned will not do the job. It must state “the individual’s conclusion of value,” which is the NACVA term above rather than a calculated value. And it governs the price: “The business valuation must support the Purchase Price … regardless of how the debt is structured. If the amount paid for the business exceeds the business valuation, the difference must be made up by equity.”

What each of those credentials requires from its issuing body is set out in our guide to exit planning consultants.

How the SBA treats a partner buyout

The SBA has a named category for exactly this transaction. SOP 50 10 8.1 defines an Owner Buyout as “a change of ownership transaction that modifies the ownership structure of the Applicant business and does not involve the acquisition of another entity or asset. At least one member of original ownership must remain in place following the transaction and guarantee the loan, regardless of the percentage of ownership post-sale.”

It has two sub-types. An Existing Owner Buyout is where “one or more current owners are purchasing the entire interest of another current owner(s), resulting in 100% ownership of the business by the remaining owner(s)” (in which case the business and the acquiring owner are both co-borrowers and the note is executed jointly and severally), or where “the small business is redeeming the ownership interest of an owner(s), resulting in 100% ownership of the small business by the remaining owner(s).” A Partial Change of Owner funds “all or a portion of one or more owner’s interest in the business or of the business itself (e.g., the purchase of treasury stock or membership units)” where at least one original owner remains and personally guarantees the loan.

There is a hard limit on bringing an outsider into the deal. For all Owner Buyout transactions, “individuals not currently employed by the business may only acquire less than 50% of the total equity and may not become the largest direct or indirect shareholder,” with indirect interests held through holding companies, trusts or limited partnerships aggregated with direct interests. A transaction that fails that test has to be processed as an Initial Acquisition instead, which is a materially different set of rules.

Requirement, SOP 50 10 8.1	Owner Buyout	Initial Acquisition
Equity injection	10%, which the lender may reduce or eliminate where there is sufficient liquidity and working capital	10%, and “the required equity injection cannot be reduced or eliminated”
Quality of Earnings report	Not required	Required where the purchase price is $3 million or more, before buyer equity, seller debt or other financing
Minimum historical debt service coverage	1.25:1	1.25:1
Non-employee buyer	May acquire less than 50% and may not become the largest owner	No such limit; this is the category an outside buyer falls into

Debt service coverage is defined by the same SOP as “earnings before interest, taxes, depreciation, and amortization (EBITDA) divided by the combined debt service post transaction,” and the SOP defines operating cash flow as EBITDA. That matters in a partner buyout, because a business run by two working owners does not get both salaries added back when a lender underwrites it.

Funding the buyout: seller notes and the standby rules

Most partner buyouts are funded by some combination of the buyer’s own cash, a bank loan and a note from the departing partner. If an SBA 7(a) loan is in the structure, the seller note is governed by rules worth knowing before you negotiate the terms.

Standard 7(a) loans have a maximum of $5,000,000. On a complete change of ownership, SBA SOP 50 10 8 (effective June 1, 2025, and in force through September 30, 2026) requires “an equity injection of at least 10 percent of the total project costs,” and states that “seller debt may not be considered as part of the equity injection unless it is on full standby for the life of the SBA loan, and it does not exceed half of the SBA-required equity injection.” Full standby means what it says: “no payments of principal or interest for the term of the 7(a) loan,” documented on SBA Form 155 or equivalent. SOP 50 10 8.1 carries the same ceiling forward, stating that limited sources including standby seller debt “may provide no more than half of the required Equity Injection.”

The refinancing window changed. Under SOP 50 10 8, seller notes had to be “in place and current (not on standby) for at least 24 months” before being refinanced. Under SOP 50 10 8.1, effective October 1, 2026, that becomes 36 months.

Here is what those rules do to a hypothetical buyout, using round numbers rather than anyone’s real deal. Two owners hold equal interests; one is bought out at an agreed price of $2,000,000, financed as an Owner Buyout.

Required equity injection at 10 percent of total project costs: $200,000, which the lender may reduce or eliminate in this category if the remaining owner’s liquidity and working capital support it.
The maximum part of that injection a standby seller note may supply is half: $100,000, on full standby, with no principal or interest paid for the life of the 7(a) loan.
The remaining $100,000 has to come from the buyer’s own funds or another source the SOP accepts.
The balance of $1,800,000 is the financed amount, and it has to clear a minimum historical debt service coverage of 1.25:1 on EBITDA against combined post-transaction debt service.

The arithmetic is illustrative. What is not illustrative is the shape of it: the departing partner who agrees to “take back paper” for part of the price may be agreeing to receive nothing on that paper for the whole life of the buyer’s SBA loan.

Life insurance is the other common funding route, and it is where Connelly sits. Insurance owned by the entity to fund a redemption, and insurance owned by the other owners to fund a cross-purchase, are different arrangements with different consequences. Which one suits a particular business is a question for a tax attorney who has read the agreement.

The tax forms and Code sections involved

Nothing below is advice about your situation. It is a map of which rules apply to which transaction, so you can ask your own adviser the right question.

Selling a partnership interest. Under IRC section 741, “in the case of a sale or exchange of an interest in a partnership, gain or loss shall be recognized to the transferor partner,” and that gain or loss is capital “except as otherwise provided in section 751.” Section 751 is the exception that surprises people: amounts received attributable to “unrealized receivables of the partnership” or “inventory items of the partnership” are treated as “an amount realized from the sale or exchange of property other than a capital asset,” in other words as ordinary income. A departing partner in a service firm with uncollected billings is squarely inside that rule.

Payments to a retiring partner. IRC section 736 splits liquidating payments in two. Payments “made in exchange for the interest of such partner in partnership property” are treated under subsection (b) as a distribution, but that category excludes amounts paid for “unrealized receivables of the partnership (as defined in section 751(c))” and for “good will of the partnership, except to the extent that the partnership agreement provides for a payment with respect to good will.” Everything else falls under subsection (a) and is treated as a distributive share of income or as a guaranteed payment under section 707(c). Note the words in the statute: whether the agreement provides for a payment with respect to goodwill changes the answer. That is a drafting decision made years before anyone leaves.

Selling the whole business rather than one interest. The IRS position is that “the sale of a business usually is not a sale of one asset. Instead, all the assets of the business are sold,” each treated as sold separately, and “the residual method must be used for any transfer of a group of assets that constitutes a trade or business.” Section 1060 requires consideration to be allocated across seven asset classes, both sides report it on Form 8594, and a written allocation the parties agree binds both of them “unless the Secretary determines that such allocation (or fair market value) is not appropriate.”

Getting paid over time. Publication 537 defines an installment sale as “a sale of property where you receive at least one payment after the tax year of the sale,” reported on Form 6252 under section 453. Regular inventory sales, dealer dispositions and publicly traded securities are not eligible. Depreciation recapture is not deferrable: “you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year,” on Form 4797 Part II.

The additional tax on the gain. The net investment income tax under section 1411 is 3.8 percent on individuals, estates and trusts above modified adjusted gross income of $250,000 (joint or surviving spouse), $125,000 (married filing separately) and $200,000 for everyone else, reported on Form 8960. Those thresholds are set by statute and are not adjusted for inflation.

The rate on what is left. For tax years beginning in 2026, Rev. Proc. 2025-32 sets the long-term capital gains brackets. A single filer pays 0 percent up to $49,450 of taxable income, 15 percent up to $545,500 and 20 percent above it; for married filing jointly the figures are $98,900 and $613,700. Unrecaptured section 1250 gain is taxed at 25 percent. One point worth correcting: holding a business longer than a year does not improve the rate, and the only place a longer hold changes the outcome is section 1202, which applies to qualified small business stock and not to a partnership or LLC interest.

Who to bring in, and when

Four people, and they are not interchangeable. An attorney drafts and reads the buy-sell agreement, and is the only one of the four who can tell you what a redemption clause does in your state and under your entity’s documents. A credential holder from the SBA’s list prepares the valuation, and if a lender is involved, that valuation has to be commissioned by the lender rather than by you. A CPA or enrolled agent works the section 741, 751 and 736 questions against your actual books and files the returns. A lender tells you, before anyone spends money, what it needs to see. If the business is past a few million in revenue and the monthly numbers are not clean enough to survive a buyer’s diligence, that is fractional CFO work rather than exit planning. To find a CPA firm near you, start with our directory.

Frequently Asked Questions

What does Connelly v. United States mean for a buy-sell agreement funded by life insurance?

The Supreme Court held unanimously on June 6, 2024 that “a corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces a corporation’s value for purposes of the federal estate tax,” in a case where the company held $3.5 million of life insurance on each of two brothers to fund a redemption. The Court pointed to how the agreement was structured as the reason for the outcome. Whether a specific agreement should be changed is a question for the owners’ own tax counsel, not something a general article can answer.

Can an SBA loan pay for one partner to buy out another?

Yes, under the Owner Buyout category in SOP 50 10 8.1. At least one original owner has to remain in place after the transaction and guarantee the loan. Individuals not currently employed by the business may only acquire less than 50 percent of the total equity and may not become the largest owner, directly or indirectly; a deal that fails that test is processed as an Initial Acquisition instead.

Can the departing partner finance the buyout themselves?

Partly. Where an SBA 7(a) loan is involved, a seller note only counts toward the required equity injection if it is on full standby, meaning no payments of principal or interest for the term of the 7(a) loan, and it cannot supply more than half of that injection. Under SOP 50 10 8.1, seller debt becomes eligible for refinancing once it has been in place and current for 36 months, up from 24 months under the previous SOP.

Is the money a retiring partner receives taxed as capital gain?

Not necessarily, and the split is written into the Code. Section 741 treats gain on the sale of a partnership interest as capital, but section 751 pulls out amounts attributable to unrealized receivables and inventory and treats them as ordinary. For liquidating payments, section 736 separates payments for the partner’s interest in partnership property from payments treated as a distributive share or a guaranteed payment, and whether the partnership agreement provides for a payment with respect to goodwill changes which side of the line part of the money falls on.

Who should prepare the valuation used in a partner buyout?

If a lender is financing it, the answer is set for you: SBA SOP 50 10 8.1 requires the valuation to come from a Qualified Source accredited as an ASA, CBA, ABV, CVA or BCA, to be requested by and prepared for the lender rather than for the buyer or seller, and to state a conclusion of value. If no lender is involved, the agreement itself should name the standard, and a conclusion of value carries more weight in a dispute than a calculated value, which NACVA requires to be labeled as such.

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