Lecture Notes: Business Life Insurance - Buy-Sell Agreements

Introduction

• Focus on buy-sell agreements in small businesses in Canada.
• Important for ensuring business continuity and family financial security if a shareholder dies.

Key Concepts

Buy-Sell Agreement

• Legal document for ownership transfer if a partner/shareholder dies.
• Specifies who buys/sells, price calculation, and use of life insurance for funding.
• Guarantees a buyer and a sale price.

Funding Buy-Sell Agreements

• Insurance policies are commonly used to fund these agreements.
• Three main methods of structuring insurance for buy-sell agreements:
  1. Crisscross Insurance Method
  2. Promissory Note Approach
  3. Share Redemption Method

Crisscross Insurance Method

• Each shareholder owns an insurance policy on the life of the other.
• Funded out of their own pocket with after-tax dollars.
• Benefits are tax-free, ensuring funds for share purchase.
• Challenges:
  • Cost discrepancies due to age, health, and smoking status.
  • Potential need for salary/bonus adjustments to cover costs.

Promissory Note Approach

• The corporation owns the insurance policies.
• Corporation pays for insurance, often more tax-efficiently.
• Death benefit paid to company, not directly to the survivor.
• Surviving shareholder uses a promissory note to buy deceased's shares.
• Dividend from company’s capital dividend account used to settle promissory note.
• Ensures surviving shareholder becomes sole owner.

Share Redemption Method

• Similar to promissory note; corporation owns insurance.
• Two separate agreements between each shareholder and the corporation.
• Company redeems and cancels deceased's shares.
• Surviving shareholder ends up owning the entire company.

Summary

• Crisscross Method: Personal ownership of insurance; direct obligation to buy/sell.
• Promissory Note: Corporation ownership; promissory note used for share purchase.
• Share Redemption: Corporation buys back and cancels shares.
• Each method has different tax implications and logistical approaches to ensure business continuity and equity transfer.