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Corporate Insurance, Life & Health Insurance

Buy-Sell Provisions in a Shareholder Agreement

Jeff Graham, CFP, CLU

One commonly overlooked component of a Shareholder’s Agreement are the Buy-Sell provisions

A Shareholder’s Agreement, or Partnership Agreement, is a crucial legal document for any company. Think of it like a will for the business. It outlines the rights, obligations and expectations of the shareholders. It looks at valuation methods, management decisions, and many other material items. It will also set forth contingencies if unanticipated events or disputes arise within the business. An easy way to compartmentalize what “events” a Shareholder’s Agreement will address is with the “5 D’s”:

  1. Death
  2. Disability
  3. Divorce
  4. Disagreement
  5. Divestment
One crucial component of a Shareholder Agreement are the Buy-Sell provisions. These provisions tackle scenarios in which owners might have to exit the business, which can be voluntary or involuntary. The provisions will set forth clear guidelines for handling any unanticipated events and how the purchase of an owner’s shares would be valued and paid for. This provides the business with contingency plans and safety nets.

Here is how Buy-Sell provisions work:

Two individuals are in business together. Each of them own 50% of the shares of a successful business valued at $2 million (each of their shares having a fair market value of $1m).  Suddenly and unexpectedly, Shareholder “A” passes away.  His spouse is the sole beneficiary to his estate (including his company shares). Now, she has 50% ownership of the company.
Does Shareholder “B” want to be in business with his late partner’s spouse? Does the surviving spouse have any interest in being an owner of the business? More often than not, the answer to both questions is “no.”
How do we avoid the above situation? First, we need to ensure the business is prepared for unanticipated events, such as the premature death of a shareholder. Secondly, how do we ensure the owner’s loved ones are receiving fair market value for their share in the business? And, at the same time, how do we ensure that the surviving owners are not put in a situation that is detrimental to the business going forward?
The solution to these potential problems is by having Buy-Sell provisions as part of a current (& binding) Shareholder Agreement.
Taking it a step further, ensuring those aforementioned Buy-Sell provisions are properly funded is of paramount importance. Without adequate (accessible) capital to purchase an owner’s shares, those provisions hold no weight.  This is where life and health insurance come into play: a properly set-up Buy-Sell structure would include funding to “buy-out” the shares from the spouse or estate, and insurance is often the most effective way to accomplish that. At First Oak Financial, we specialize in setting up the “funding” piece of this puzzle.

In summary, here is how it looks on a step-by-step basis (assuming there are 2 shareholders):

  1. The corporation purchases life insurance policies on the lives of both shareholders.
  2. When Shareholder “A” passes away, the corporation receives the life insurance proceeds.
  3. The corporation pays the deceased shareholder’s spouse and in return purchases the shares back at the pre-determined value.
  4. The surviving spouse has now received fair market value for the business thanks to the life insurance proceeds.
  5. Shareholder “B” now owns 100% of the shares.

The end result will be a business that has the opportunity to continue operations and not be bogged down by potential ownership issues and costly, time-consuming litigation.  For the family of the deceased, this removes the stress and uncertainty over how to receive fair value for the business. It also provides liquidity and closure.

Contact Jeff Graham at (604) 363-7549 or jeff@firstoakfinancial.ca for more information.

DISCLAIMER: this is a surface-level summary of the process for funding Buy-Sell provisions. There are different ways to structure the insurance policy ownership and payout methods. The tax and legal components need to be explored in depth with your trusted professionals. This commentary is provided for general informational purposes only and does not constitute financial, insurance, investment, tax, legal or accounting advice.

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