Buy-Sell Funding: Making Your Shareholder Agreement Actually Work

If a partner dies and there's no money set aside, the surviving owners may need to borrow, drain the business, or pay the family over many years. Or they may end up in business with their late partner's spouse or estate, whether anyone wants that or not. Families can be left waiting for money they need now, and partnerships that worked well for decades can turn into disputes.

Life insurance is usually the most cost-effective way to fund a buyout if an owner dies. When the policy pays out, the money goes where the agreement says it should, and the family receives fair value for the shares.

Disability insurance can fund a buyout if an owner becomes permanently disabled and can no longer work in the business. That part of the agreement is often overlooked.

There are several ways to set this up:

• Each owner owns a policy on the other owners, sometimes called a criss-cross arrangement
• The corporation owns a policy on each owner
• A holding company structure, depending on how your business is organized

Each approach has different tax results, especially around the capital dividend account and how the shares are taxed when an owner dies. This is where we work closely with your accountant and lawyer to make sure the insurance matches the agreement.

Buy-sell agreements are often set up once and then forgotten. Meanwhile, the business grows. If the insurance was based on what the company was worth years ago, there can be a big shortfall at exactly the wrong moment. We recommend reviewing the valuation and the coverage together every few years, or whenever the business changes significantly.