Buy-Sell Agreement vs Operating Agreement: Why You Need Both

"We already have an operating agreement" is not enough.

This is the most common thing we hear from founders who think they're covered. They formed their LLC, their lawyer drafted an operating agreement, and they assume ownership transitions are handled.

They're not. An operating agreement and a buy-sell agreement are two different documents that do two different jobs. Your operating agreement governs how the company runs while everyone is alive and working. Your buy-sell agreement governs what happens when someone dies, becomes disabled, leaves, or needs to be removed.

Confusing the two — or assuming one covers the other — is one of the most expensive mistakes founding teams make.

What an operating agreement does

Your operating agreement is the foundational governance document for your LLC. It defines how the company operates on a day-to-day basis:

• Ownership percentages: Who owns what share of the company.
• Management structure: Whether the LLC is member-managed or manager-managed, and who has authority to make decisions.
• Voting rights: How decisions get made — unanimously, by majority, or by designated managers.
• Profit and loss allocation: How money gets distributed to members.
• Capital contributions: What each member contributed and what happens if additional capital is needed.
• Roles and responsibilities: Who handles what in the business.

It's an essential document. Every multi-member LLC needs one. But it's designed for normal operations — the steady state where everyone is alive, healthy, and working together.

Where operating agreements fall short

Most operating agreements have a section that vaguely addresses what happens when a member dies or wants to leave. Typically, it says something like "the remaining members may purchase the deceased member's interest" or "a departing member shall offer their interest to the remaining members."

That sounds reasonable. Until you try to execute it under pressure.

Here's what a typical operating agreement doesn't specify:

• How the company is valued. "Fair market value" without a specific valuation method means you're negotiating with a grieving family or a hostile departing founder with no agreed-upon number. Is it a revenue multiple? An earnings multiple? A third-party appraisal? A formula? If the agreement doesn't say, you're heading for a dispute.
• Where the money comes from. Even if you agree on a price, how do the remaining founders actually pay for the departing member's share? Out of pocket? Company cash flow? A loan? Most operating agreements say the remaining members "may purchase" the interest but don't explain how a 30-year-old founder is supposed to come up with $500K in cash.
• The timeline for the buyout. Does the departing member get paid immediately? Over 5 years? Over 10? While they wait, do they still have voting rights? Do they still receive profit distributions? Vague operating agreements leave all of this open to interpretation.
• What happens to the deceased member's share. Does it transfer to their spouse? Their estate? Can their heirs vote on company decisions? Can they block a sale? Without specific terms, you might end up with your cofounder's estranged spouse as your new business partner.
• Disability provisions. Most operating agreements don't address what happens if a founder becomes permanently disabled but doesn't die. They can't work, but they still own their share. Now what?

What a buy-sell agreement does

A buy-sell agreement answers every question your operating agreement leaves open. It's a binding contract between co-owners that specifies exactly what happens to ownership when a triggering event occurs.

A well-drafted buy-sell agreement defines:

• Triggering events: Death, disability, voluntary departure, termination for cause, divorce, bankruptcy, retirement. Every scenario that could affect ownership.
• Valuation method: A specific formula, a fixed price updated annually, or a defined appraisal process. No ambiguity, no negotiation under pressure.
• Purchase obligation: Whether the remaining members are required to buy (mandatory buy-sell) or have the option to buy. In most startup contexts, you want a mandatory provision — you don't want a dead founder's heirs stuck with illiquid equity and no buyer.
• Funding mechanism: How the purchase will actually be paid for. This is where key man insurance comes in — life insurance policies fund the buyout so nobody has to scramble for cash.
• Payment terms: Lump sum or installments. Timeline. Interest rates on deferred payments.
• Restrictions on transfer: Prevents founders from selling their shares to outsiders without approval.

How the two documents work together

Your operating agreement and your buy-sell agreement aren't competitors — they're complements. Think of it this way:

Operating agreement: How we run the company together.
Buy-sell agreement: How we handle it when we stop running the company together.

The operating agreement governs the present. The buy-sell agreement governs the transitions. You need both because business ownership involves both normal operations and ownership changes — and the stakes are too high to improvise on either one.

In practice, your buy-sell agreement should reference your operating agreement and be consistent with it. If your operating agreement says ownership is 60/40, your buy-sell agreement should use that same split. If your operating agreement defines certain valuation principles, your buy-sell agreement should build on them with specificity.

Some lawyers draft buy-sell provisions directly into the operating agreement. That can work, but only if the provisions are comprehensive — specific valuation methods, funded purchase mechanisms, and clear timelines. A two-paragraph section that says "remaining members may buy" is not a buy-sell agreement. It's a placeholder.

What about C-corps and S-corps?

If your startup is a C-corp (common for VC-backed companies), you don't have an operating agreement — you have bylaws and a stockholders' agreement. The same principle applies. Your bylaws and stockholders' agreement handle governance. A separate buy-sell agreement (or comprehensive provisions within the stockholders' agreement) handles ownership transitions.

For C-corps with venture funding, the buy-sell provisions often interact with your vesting schedule, ROFR clauses, and investor consent rights. These need to be carefully coordinated with your existing cap table agreements.

When to put these in place

Operating agreement: Day one. Before you write a line of code or close your first customer. This is foundational.

Buy-sell agreement: As soon as you have a cofounder or co-owner. The earlier the better — it's infinitely easier to agree on fair terms when everyone is healthy, optimistic, and working well together. Trying to negotiate buyout terms after a triggering event is adversarial by nature.

If you already have an operating agreement but no buy-sell agreement, you have a gap. It's the kind of gap that doesn't matter until it matters enormously — at which point it's too late to fix. See What Happens When a Cofounder Dies for a detailed look at what that gap costs.

The next step

If you're not sure whether your current agreements cover ownership transitions — or you know they don't — it's worth a 15-minute conversation to assess where you stand. Book a call and we'll review your situation, identify the gaps, and lay out exactly what you need.

Coverage subject to underwriting approval. Insurance products vary by state. Consult your tax and legal advisors for situation-specific guidance.