As a business owner, it is important to plan for significant life events and their affect on your operations, before they happen. Knowing what happens if one of the partners passes and diligently protecting the business and its value (and therefore the family) is the sensible thing to do. One way to safeguard your business and ensure that is by addressing the consequences of an early passing or “exit strategy” of one (or more) of the business partners through a buy-sell agreement. A solid buy-sell agreement needs to be optimally structured and adequately funded. Something we’ll touch on in this post.

The death or permanent disability of a business partner or a shareholder can have a significant impact on the long-term viability of your business. It’s crucial to factor this into your company’s financial planning. Yet so many don’t! Also, if your business loses an owner, the remaining owner(s) must decide how to continue operations, minimize disruption and maintain control of the business if ownership of shares changes hands.

So, as a partner or shareholder in a business, do you have a plan in place specifying what happens if a key player in the business dies or is forced to withdraw? Your business depends on it.

Ensuring continuity and clarity

A buy-sell agreement can help protect you and your business by laying out a clear path forward. Depending on your objectives and the specific terms of the agreement, it may specify what happens when a shareholder chooses to leave the business, is forced out or passes away.

Buy-sell agreement can be funded by various methods, including loans, insurance policies and accumulated earnings. In situations where a buy-sell agreement is triggered by the death of a shareholder, life insurance is an attractive funding option given the potential tax advantages that it provides.

A tax-advantaged solution

There are three main ways in which your business can use life insurance to fund a buy-sell agreement:

1. Cross-purchase method

Each shareholder purchases a life insurance policy on the life of the other shareholder(s), naming themselves as the beneficiary. If a shareholder dies, the buy/sell agreement requires the surviving shareholder(s) to purchase the shares of the deceased shareholder at fair market value. The life insurance benefit is used to fund this purchase.

2. Promissory note method

The company purchases a life insurance policy on the life of each shareholder, with the corporation as the beneficiary. If a shareholder dies, the buy/sell agreement requires the surviving shareholder(s) to purchase the shares of the deceased shareholder at fair market value. The life insurance benefit is paid into the company’s capital dividend account, which is then distributed to the surviving shareholder(s) and used by them to fund the purchase of shares.

3. Corporate redemption

The company purchases a life insurance policy on the life of each shareholder, with the corporation as the beneficiary. If a shareholder dies, the buy/sell agreement requires the company to purchase and absorb the shares of the deceased shareholder at fair market value. The life insurance benefit is used by the company to fund the purchase of shares.

The ultimate outcome

Which of these three approaches is best for your business will depend on a variety of factors, but the ultimate outcome will be the same: less uncertainty for your business, strengthened control of ownership following the death of an owner, and a tax-efficient approach to funding the purchase of the deceased owner’s shares.

We have experience structuring the optimal life insurance solutions for funding buy-sell agreements. To learn how you can safeguard your business interests and ensure continuity in the face of uncertainty, contact us today.