In order to ensure the orderly succession of a business, it is wise for business owners (whether they are incorporated or not) to enter into a buy-sell agreement. The buy-sell agreement creates the conditions for purchase due to an unexpected event to one or more of the owners of the business. This could include, but is not limited to, death, severe disability, retirement, divorce, becoming legally incompetent, convicted of certain criminal offences, or personal bankruptcy. The buy-sell agreement dictates the price and conditions of the sale of shares if one of these events occurs.

Surviving owners want to ensure the continuity of ownership, and not risk having a large share of ownership fall into the hands of potentially inexperienced heirs of the deceased, ill, or disabled. In addition, they want to protect themselves and the company financially.

For the most part, a challenge with executing the buy-sell agreement is coming up with the funds to make the purchase. Lending from third parties is generally difficult when a business is going through the tumult normally associated with the events described in the previous paragraph. However, it is possible to put insurance in place to provide funding in the event that any of these specific events occurs.

Buy-sell insurance funds a win-win outcome

Buy-sell insurance is a good way to protect everyone’s interests. It funds the purchase of the remaining shares if a partner, co-owner, or shareholder in unable to remain actively involved in the business. 

Advantages of an insurance funded buy-sell agreement

• Can provide immediate liquidity to fund the agreement.
• Establishes a mutually agreeable price and terms to reduce potential future litigation or friction.
• It helps facilitate a smooth transition of management.
• Ensures that the family of the deceased receives cash instead of unmarketable stock.
• Protects the company’s liquidity needs at a potentially vulnerable time.

Life Insurance

If a partner/shareholder in the company passes away, the surviving partner uses the tax-free proceeds from the insurance policy to buy up the outstanding shares. The heirs receive full market value for the deceased owner’s shares and the surviving partner can assume full ownership without having to sell assets or borrow money.

Life insurance can also be used to fund a buyout when a partner does not pass away – think about retirement, divorce where the ex-spouse gets shares in the company as part of the divorce, or simply a breakdown between the partnership/shareholders of the business. This can be achieved using insurance as well, specifically permanent insurance.

Permanent life insurance can have a cash value embedded within, which can be withdrawn or used as collateral for a loan and ultimately utilized to purchase business shares.

Disability Insurance

Your business’ success depends on the productivity of a core team of partners—if you or one of them becomes disabled, your business can suffer.

The proceeds from the disability insurance policy are used to buy out the shares/ownership of the business of a disabled partner if they will be out for so long that it makes sense to leave the business. Disability buyout coverage can provide either a lump sum payment or monthly installments, whichever you choose.

An important note: The disability portion of a buy-sell agreement must have enough flexibility to not force someone to sell their business interest and withdraw from the company when, given enough time, that person could return to normal duties. Often, the agreement will have a survival period before the buy-sell arrangement is triggered (for example a period of 1-2 years).

Often, the disabled person who has been unable to work for a long period of time experiences financial hardship and welcomes the additional money provided by the buy out coverage.

The right advice makes all the difference

As with any decision regarding your business, speak with your business advisor to make sure your decisions are well-informed and aligned with your overall plan.

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