Securing Success: Demystifying Buy-Sell Agreements for Canadian Business Owners

If you are a Canadian business owner who has partners or co-owners, you may have heard of a buy sell agreement. But what is it and why is it important? In this blog post, we will explain the basics of a buy sell agreement and how it can protect your business and your family in case of death, disability, divorce, or retirement of one of the owners.

A buy sell agreement is a legal contract that specifies what will happen to the ownership and control of the business if one of the owners dies, becomes disabled, gets divorced, or retires. It also sets the price and terms of the sale of the owner's shares to the remaining owners or to a third party. A buy sell agreement can help prevent disputes among the owners and their heirs, ensure continuity of the business operations, and provide liquidity for the departing owner or their estate.

There are different types of buy sell agreements, depending on who is obligated or has the option to buy the departing owner's shares. The most common types are:

1. Cross-purchase agreement: The remaining owners agree to buy the departing owner's shares at a predetermined price and terms. This type of agreement gives the remaining owners more control over the business, but it may require them to have enough cash or financing to complete the purchase. For example, if there are three owners and one of them dies, the other two owners will each buy 50% of the deceased owner's shares from their estate.

2. Redemption agreement: The business entity agrees to buy the departing owner's shares at a predetermined price and terms. This type of agreement reduces the financial burden on the remaining owners, but it may affect the tax treatment of the sale and the valuation of the business. For example, if there are three owners and one of them retires, the business entity will buy 100% of the retiring owner's shares from them.

3. Hybrid agreement: A combination of cross-purchase and redemption agreements, where the business entity and the remaining owners have the option or obligation to buy the departing owner's shares. This type of agreement provides more flexibility and can accommodate different scenarios. For example, if there are three owners and one of them becomes disabled, the business entity may have the first option to buy their shares, followed by the other two owners.

One of the challenges of a buy sell agreement is how to fund the purchase of the departing owner's shares. One of the most common and cost-effective ways to fund a buy sell agreement is with life insurance. Life insurance can provide a lump sum of cash at the time of death or disability of an owner, which can be used to buy their shares from their estate or beneficiary. Life insurance can also offer tax advantages, such as tax-free death benefits and tax-deferred cash value growth.

To fund a buy sell agreement with life insurance, each owner can buy a policy on their own life and name the other owners or the business entity as beneficiaries (cross-purchase agreement), or the business entity can buy a policy on each owner's life and name itself as beneficiary (redemption agreement). Alternatively, each owner can buy a policy on their own life and assign it to the business entity as collateral for a promissory note (hybrid agreement).

A buy sell agreement is an essential part of any business succession plan. It can help you protect your business and your family from unforeseen events that may affect your ownership and control. If you are interested in learning more about how to create and fund a buy sell agreement for your business, please contact us today. We are happy to help you with your business planning needs.