this is the third of our session on Business Insurance business life insurance and we're going to talk today about Buell agreements um buy sell Agreements are actually quite prevalent in uh small business in Canada and what's important about a buy sell agreement is that if something happens to me I'd like to know that someone is going to buy my equity in my business because in fact my family needs those dollars to continue to live uh if in fact they're not working in the business in most situations uh if I were to die and there's nobody to buy my business a my business is going to suffer because there's nobody there to run it B it's going to take an awful long time for me to find a seller sorry a buyer of my business and in fact what they want to pay me knowing that I my estate is in a quandry we need to get the business sold they may not be willing to pay me the full market value so we have something called a buy sell agreement uh that shareholders normally enter into to ensure that they don't run into these kinds of problems if in fact something untimely happens to one of the shareholders so a buy sell agreement is an agreement where someone is obligated to buy and the other party is obligated to sell Buy sell agreement so we're planning for the ownership transfer in the event of the death of a partner or a shareholder and this agreement which is a legal document you'll have to have your uh legal your lawyers uh and legal counsel prepare this document it's an agreement which specifies who is going to buy who is going to sell it specifies how much you're going to pay so there's usually a formula in this agreement and it usually indicates that the purchaser will will use life insurance to in fact effect the purchase to have the cash to make the purchase so in a lot of scenarios if we just have simply two shareholders I myself and my partner are shareholders in a company I might own an insurance policy on her life she would own one on my life if either one of us dies the Survivor would collect the insurance proceeds and use that money to buy the shares of the deceased so the beauty about a buy sell agreement is first of all we have a guaranteed buyer something happens to one shareholder for sure there's someone there guaranteed to buy their share in addition to that we have a guaranteed sale price we know we have a formula in the agreement which is going to be used to calculate how much the shares are worth the sale is going to take place the Survivor doesn't have an option to buy they are obligated to buy in the event of death and the money is available because they had life insurance in place to provide those liquid proceeds that are going to be receive going to be available to make and complete the purchase so Buell agreements very prevalent in the business Marketplace and you know if you have one in place it should be funded with life insurance and we're going to talk about different ways to fund different ways to own that uh Insurance there are three ways that we can structure the ownership of insurance if we're going to fund a buy sell agreement first is called the crisscross Insurance method second promisory note third share Redemption method so all three of these methods are designed to support the funding of a byell agreement and the implementation or execution of the agreement in the event that one or more people die uh who are covered under the agreement so let's first talk about crisscross insurance we discussed uh the opportunities under the business uh life insurance Marketplace and uh one of the things we uh talked about uh is that of a buy sell agreement and so that's an agreement between or among shareholders where in the event that something happens to one shareholder the other shareholder or shareholders have the opportunity to purchase uh the deceased shares and to pay them a fair price as outlined under a formula in a buy sell agreement and so uh many small businesses where there are more than one uh shareholder or partner will enter into Buy cell agreements uh it is appropriate for these agreements to be funded with usually life insurance so that in the event of uh a death an untimely death the survivors have the actual liquid cache uh in order to make the purchase from the deceased estate and there are three types of uh ways we can structure that funding and so let's take a look at actually the simplest way which is Simply Having what we call crisscross ownership crisscross insurance and let's take our two shareholders A and B and let's assume they may be a owns 40% of the company and B owns 60% of the company and what they want to do is to make sure that if either one of these parties were to die prematurely the Survivor would have the opportunity to buy the shares from the deceased and in the agreement uh the price formula is already in there and there's going to be an obligation for one to sell and one to buy and now we need life insurance in place to affect the deal to provide the liquid cash so we can carry that out so in a simple crisscross Insurance method uh shareholder a owns a policy on the life of shareholder B and shareholder B owns a policy on the life of shareholder a let's assume this business is worth a million dollar we would set up the funding where shareholder a will in fact own a policy for $600,000 because that's the value of shareholders B equity in the business and so if B were to unfortunately die a would have $600,000 of the death benefit to go to be's estate and purchase be's shares and so crisscross ownership is very simply a owns the insurance policy on b b owns the insurance policy on a and they pay for that out of their own pocket they pay for it with their own after tax dollars now some of the challenges even though it seem seems pretty simple some of the challenges we have in this scenario uh are that the cost of the insurance can be very different for the two parties uh number one first of all one has a bigger Equity than the other number two one could be older than the other number three one could be a smoker the other ones is a non-smoker and so the differentiate the difference is in the cost of that insurance can be pretty significant especially since they're paying for it right now out of their own pockets and so sometimes companies will have to increase uh the salaries of uh the shareholders maybe pay them a bigger bonus in order for them to have enough money to fund the agreement so in it's while it's simple in terms of crisscross it's not perfect there are some issues around there and we are going to talk uh in the next segment about something called the promisory note approach which tends to tries to overcome some of these discrepancies or these issues that come out from a simple crisscross approach so in summary if we go back crisscross Insurance each shareholder enters into an agreement with the others each party buys insurance on the other person's life each party pays for that insurance themselves so I own a policy on my partner's life and I pay for it my partner owns one in my life he or she pays for it this is coming out of our pocket it's not tax deductible but the benefit will be taxfree if either one of us dies and the money is going to be available to in fact go to the estate of the deceased and say I have an obligation under the agreement to buy your shares here's the money for the shares transfer to me those shares so now I am the owner of the entire company and so Chris gross Insurance pretty simple a owns on b b owns on a let's look at the second term promisory note approach now the promisory note approach addresses the differences in premiums we could have if one partner is older could be older could be a male could be a smoker the other partner could be younger might be female might be a non-smoker so there could be a huge discrepancy in the cost of the insurance and while under the crisscross method I need to buy on my my business partner and she needs to buy on me the reality is that it's going to cost her a lot more money for the insurance if I am older and a smoker or not as healthy so those discrepancy es in the cost of the insurance uh brought about the use of this approach called the promisory note approach and what a promisory note what's different here is that instead of the shareholders each owning Insurance on each other's life we get the company the corporation to own the insurance so the corporation owns the insurance pays for it and in fact if there is a death the proceeds of the insurance are payable to the corporation now let's take a look if I said to you I'm obligated to buy an event of the death of my partner but if the money is in the wrong place the money is sitting in the company how am I going to get my hands in that money to continue uh and to fulfill the purchase I have under the buy sell agreement so let's go to the board and I'm going to explain to you how this promisory note approach Works a second approach to funding a bell agreement is something called the promisory note approach you may recall when we talked about the crisscross approach that there were some issues with that with respect to the cost of the insurance especially if there are varying ages or varying Health scenarios for the uh two business partners in my example and so one way to get around that discrepancy in the actual cost is to have the insurance owned by the corporation uh the corporation is still going to pay for that income tax sorry that insurance uh with after tax dollars but it usually is in a much lower tax bracket than the individual shareholders so from a tax efficiency standpoint uh it makes sense to have the corporation pay for the insurance uh in order to support the funding uh however one of the issues we have when the corporation owns the insurance is that in the event of a death that insurance money is sitting in the death benefit is sitting in the corporation however it is the individual surviving shareholder that has to make the purchase and so that surviving shareholder actually doesn't have that money because that money is in the wrong place that money is sitting in the corporation and so uh you may recall in another segment where we covered the capital dividend account the capital dividend account was that special account that allowed us to pay a tax-free dividend and a big portion of our insurance death benefit uh actually gets credited to that Capital dividend account so when we look at the promisory note approach basically what happens is the two shareholders enter into a buy sell agreement this is a legal document that they've entered into with each other and the insurance is owned the company owns a policy on shareholder a and the company owns another policy on shareholder B and so the company owns pays for the policy and is in fact the beneficiary of that policy so if one of the shareholders passes away the insurance company will write the death benefit check to the company and as we learned uh that money will be the accountant will deposit that in the company's bank account and again I'll just use a simple amount of $100,000 uh we see this side of the balance sheet going up to 100 and on this side we make the credit to the retained earnings account of the policy's adjusted cost base and to the capital dividend account we credit the difference between the death benefit and the ACB and in my previous example I used an example where this was $88,000 and this was $92,000 and so this side now is in inbalance now one of the issues is this is the treatment at the corporate level on its liability asset and liability statement the shareholder still has the opportunity or still has to go and buy the shares so what happens the shareholder the surviving shareholder goes to the estate of the deceased and says I am obligated under this agreement to buy your shares the dece shares and I have to and the deceased estate has to sell it that's what we have under the agreement but you know what I don't have any money I have to buy it but I haven't got any money will you executive of the estate accept a promisory note an IOU I owee you $100,000 for the deceased shares I don't have the money will he accept an IOU and the executive understanding the structure says no problem I'll accept anou and once I have accepted the IOU I transfer the share over to the surviving shareholder so that's a very important piece of this transaction uh I now as the surviving shareholder I have my original share and now I own the deceased share I haven't paid for it yet but I am the owner and so now that I own both shares in my example I go to the company to the accountant and I say to that accountant I want you to pay me a capital dividend from the from the capital dividend account of $992,000 now you know Dividends are paid only to shareholders so now who are the only shareholders in this deal well it's the surviving shareholder the surviving share holder has one share that they had from the beginning and now they have the other share they got from the deceased estate so they own both shares and therefore they own all of the company and so that when we declare this dividend they're going to get the entire $992,000 and they can use that to offset or pay off that $100,000 uh loan that they had for the purchase of the shares so it won't be exactly equal to 100 but it's certainly going to go a long way to help them complete the purchase of the deceased shares so once we have the company owning the insurance we have to go through this promisory note process in order that we can transfer the deceased shares to the Survivor now the Survivor owns all the issued shares in the company they then declare the dividend and they now have the money if this dividend was declared before before that share was transferred the Survivor would only receive half of that amount because they only owned one share and the estate would have received the other half so we don't want that to happen so it's very important in this process for the surviving shareholder to now own both shares declare the dividend and then pay off the promisory note so in summary the corporation buys the insurance on each shareholder because it takes less company dollars to pay for the insurance as I explained on the board uh and so the company owns the insurance the premiums are paid for by the company out of its own uh after tax dollars on the death of a shareholder the Survivor of goes to the estate and says to the estate I am obligated on the agreement to buy the share of uh my ex partner however I don't have any money but I need to get those shares and I will pay for it with an IOU I'll give you a promisory note I promise to pay for you pay you for those shares and so your executive the executive of deceased transfers the share over to the Survivor so now the Survivor has both shares has the original one she had plus the one she just bought from my estate she's bought it from my estate she just hasn't paid for it as yet so she owes for it she then goes back to the company and says to the accountant I want you to issue me a capital dividend a dividend from the capital dividend account which we explained on the board she receives that dividend taxfree because it's deemed to be Capital she then uses that money to pay off the IOU or the promisory note so uh the whole concept of having the insurance owned by the the company necessitates the need to have this promisory note structure put in between the process so uh let's talk now about the third option which is called share Redemption uh approach again I'll give that example on the board a third method of funding a buy sell agreement uh is in fact referred to as the shareholder Redemption approach now this is fairly similar to the promisory note approach in that the insurance is owned by the corporation however what's different is that there is no agreement uh between the two shareholders in fact each shareholder enters into an agreement with the company so shareholder a will have a share Redemption agreement with the corporation shareholder B will have a share Redemption also with the corporation so there are two separate agreements there isn't one buy sell agreement they are in fact two separate Buy sell agreements and in fact who is doing the purchasing is different in the share Redemption plan it is the company that is actually going to be buying the shares back from the deceased estate and when they buy them back they cancel them and so when a company buys back a share from let's say there are two shares that have been issued one to each shareholder one of the shareholders passes away and so the company buys back that deceased shareholders shares buys it back and cancel them now the only shares is issued are the shares of the surviving shareholder so that surviving shareholder as a result of the cancellation of that uh the C share now becomes the only shareholder in the company so they basically own the entire company so what's different same diagram or graph as you saw I had on the board for the promisory note approach so again the corporation would own the insurance we would go through this accounting treatment and then the corporation would go to the deceased shareholders estate and say we want to buy back that share we issued to you from day one and we are going to pay you $100,000 for that so the company does the same thing they buy back the shares and then they declare a dividend to the estate to cover the cost uh of that so they uh in the share Redemption approach the word Redemption comes to redeem something and so that's what the company does the company does the buying as opposed to the surviving shareholder so that basically uh you need to understand those three methods of uh funding a buy sell agreement crisscross promisory note and share Redemption approach so in summary the share Redemption and the promisory note approach in both of those situations the company owns the insurance in the crisscross method the individual owns the insurance in the share Redemption method instead of me being obligated to buy from my partner and my partner obligated to buy from me we actually enter into an agreement with the company so there are two agreements in place the company has a a share Redemption agreement with me and the company has a share Redemption agreement with my business associate in the event that something happens to one of us the company is actually the one that does the buying back so the company will take the money that's in the capital dividend account and they will buy back my share and cancel it and so the only share left is going to be my associate share and he or she is not going to be the full owner of the company so share Redemption said company's doing the buyback promisory note says my business partner in fact is doing the buying so that's a quick summary on the share Redemption plan