Understanding Buy-Sell Agreements for Your Clients: A Guide for Financial Advisors

As a financial advisor, helping your clients understand and plan for the future of their business is one of the most important ways to provide value. One key part of this planning is a buy-sell agreement. This agreement is vital for companies with multiple owners because it outlines how share ownership will be handled if something unexpected happens, like a shareholder retiring, becoming disabled, or even passing away.

Here’s a simple breakdown of buy-sell agreements, why they’re important, and how they can be funded with life insurance to ensure your clients’ businesses continue smoothly when difficult situations arise.

What is a Buy-Sell Agreement?

A buy-sell agreement is a legal contract between business owners that explains what happens to a business’s shares (or ownership) when a major life event occurs, such as:

• Death

• Retirement

• Disability

These agreements help prevent conflicts among shareholders and ensure the business continues without disruptions. They also help protect the value of the business and ensure that the right people are involved in running the company.

Different Types of Buy-Sell Agreements (ON DEATH)

There are several ways a buy-sell agreement can be structured, depending on the needs of the business owners. Let’s look at some common options:

1. Cross-Purchase (Personally Owned Insurance)

   
   

   In this setup, each shareholder buys life insurance on the others. If one shareholder dies, the insurance payout is used to buy their shares. This increases the remaining shareholder’s cost base (ACB), which can have tax benefits later when the shares are sold.

   
   

2. Cross-Purchase (Corporate Owned Insurance)

   
   

   Here, the corporation itself owns the life insurance policies on the shareholders. If a shareholder dies, the corporation pays out a tax-free capital dividend to the surviving shareholder after the surviving shareholder uses a promissory note to buy the deceased's shares.

   
   

3. Share Redemption (Corporate Owned Insurance)

   
   

   In this case, the corporation uses the life insurance payout to buy back (redeem) the shares of the deceased shareholder via a tax-free capital dividend. The surviving shareholders will own a larger portion of the business, without a subsequent bump up in the adjusted cost base. Due to the tax-free CDA used to redeem the shares, stop-loss issues may arise for the deceased that can be minimized or eliminated by incorporating other strategies (i.e. “50% solution”, “Hybrid” or “roll and redeem”).

   
   

4. Hybrid Agreement (Cross-Purchase and Redemption)

   
   

   This method combines the two strategies above, allowing the deceased shareholder to use their Lifetime Capital Gains Exemption (LCGE) while also deferring capital gains tax. It’s a more complex option but can provide some significant benefits.

   
   

What About Holding Companies (Holdcos)?

If your client’s business is owned through a holding company (Holdco), you’ll need to consider additional planning. In this case, you can:

• Have the holding company buy shares in the operating company (Opco) and use insurance to fund the agreement (either via a cross-purchase or promissory note)

• Or have the operating company itself redeem the shares using life insurance.

The structure you choose can affect taxes on capital gains and dividends, so it’s important to plan carefully.

Corporate vs. Personally Owned Insurance

When deciding how to fund a buy-sell agreement, there are two main options for insurance ownership:

• Corporate-Owned Insurance:

  
  

  This can offer tax savings, especially if the corporation's tax bracket is lower than the individual’s. It’s easier to manage but doesn’t provide as much protection from creditors.

• Personally Owned Insurance:

  
  

  This option offers better protection from creditors and may reduce the risk of family law claims, but it can be more complicated and costly to manage.

Questions to Ask Your Clients

To guide your clients in understanding the importance of a funded buy-sell agreement, consider asking these questions:

• Does the corporation have multiple shareholders? If so, do you have shareholders agreements with buy-sell provisions that specify what is to happen if the shareholder wants to leave the business, becomes sick, or disabled and is unable to work or one of the shareholders dies?

• If yes, is the buy/sell agreement funded with life or critical illness insurance?

• If yes, is the funding up to date? Does it reflect the current value of the business?

• What are the funding requirements?

• Can I review it?

  
  

Questions for the deceased shareholder:

• If you were to retire, die, or become disabled today, how much would you want for the value of your business?

• Do your heirs want to be active owners or passive investors? This is important because without an agreement your heirs will inherit shares.

• If your heirs do not want to be involved in the business is there a market/buyer for the shares?

• Will your heirs receive a payment equal to fair market value or a discounted value of your shares?

• Do you want your heirs to receive the value of your shares in cash to maintain their standard of living or do you want them to rely on the future of the business for ongoing living expenses?

Questions for the surviving shareholder:

• Do you want to be in business with the deceased shareholder’s heirs?

• Do you want your hard work to pay dividends to the deceased shareholder’s heirs?

• Do you want to sell personal or business assets to generate funds you will need to purchase the deceased’s shares?

• If your partner suffers from a critical illness, how long would you be willing to do 100% of the work for 50% of the profits?

  
  

These questions can help your clients think through the personal and financial impacts of a buy-sell agreement.

Why It’s Important for Your Clients

Buy-sell agreements funded with life insurance provide business continuity, protect shareholder value, and give financial security. By choosing the right structure, your clients can ensure that their businesses are prepared for the unexpected.

Call to Action

As a financial advisor, your role is to help your clients make informed decisions that protect their future and the future of their businesses. If you haven’t already discussed a buy-sell agreement with your clients, now is the time to do so.

Don't wait for an unexpected event to disrupt your clients' businesses—take proactive steps today to help secure their future and ensure their businesses stay on track.

Get started today and help your clients protect what they’ve worked so hard to build!