1. Buy/Sell Agreements

2. If you had died last night…how would these questions be answered today? Who is running the business? To whom do they report? How will your spouse get income? Who will pay creditors? Are the bank loans personally guaranteed? Are there partners? What will the partners want? Will your business interest be sold? Will your partner(s) buy? At what price? Where will they get the cash? Is this what you want?

3. Buy/Sell Agreement A buy/sell agreement is a sort of “will” for your business. It is an agreement between shareholders outlining how the business will continue its activities after the death of an owner.  It can also outline what should happen if an owner retires or becomes disabled. A properly funded buy/sell agreement provides shareholders both with a market for the seller and the funds for the buyer

4. On Death of Business Owner Options for business disposition:  Liquidation  Retention By family/heirs  Sale To business associates

5. Objectives To provide security to deceased’s family/heirs To ensure the continuation of the business

6. Liquidation Deceased's family may have cash/income needs Avoid liquidation of assets at “fire sale” prices A properly funded buy/sell agreement will guarantee that your family will get the FMV for your shares

7. Retention by Family/Heirs This could happen in your boardroom  Youthful heirs who use their inheritance to vote themselves into a position of authority can change the direction of your business  Don’t allow outsiders to walk into your business. Maintain control with a well structured buy/sell agreement

8. Sale to Business Associates A funded buy/sell agreement will ensure that:  Your family/heirs get cash equal to the Fair Market Value of the business  Your business associates receive funds that can be used to keep the business  The business’s financial stability is maintained

9. Buy/Sell Agreement A structured buy/sell agreement ensures that the needs of your family/heirs and those of your business are looked after

10. Essential Elements of a Buy/Sell Agreement The valuation formula to determine the price for the shares The financing method for the buy/sell The buy/sell method to be used upon death of a shareholder

11. How much is your business worth? It’s important to have a formula in place to determine the value of the company and avoid conflict later on. You will want to consider:  Partnership or Corporate Tax Return  Operating Statements Balance Sheet Profit and Loss Statement  Fire Insurance Policies  Audited Financial Statements  Terms for existing agreement established by partner(s)  Partners who generate new revenue

12. You have the obligation…. Now where do you get the funding? You and your partners have agreed on the circumstances that will trigger a buy/sell But where will the money come from?  Cash Make installment payments? Write a cheque for the full amount?  Borrowed Funds  Sinking Fund  Life Insurance

15. Funded by Life Insurance Exact amount is provided when needed Least expensive method vs.  future borrowing or  sinking fund

16. Various Buy/Sell Structures Exist No one is best Choose best for situation Let’s examine a potential situation

17. Company Profile XYZ Inc. FMV = $2,000,000 Owners  John owns 50% of shares ACB of John’s shares $10,000 PUC of John’s shares $10,000  Mary owns 50% of shares ACB of Mary’s shares $10,000 PUC of Mary’s shares $10,000

18. Growth rate of company2% Personal marginal tax rate on income50% Personal marginal tax rate on dividends33% Capital gains inclusion rate50% Assume John died last night Assume Mary sells the business in 10 years Company Profile

19. Buy/Sell Structures We will examine four Buy/Sell structures funded by life insurance; Criss-Cross Personal ownership Promissory note Corporate owned Share redemption Corporate owned Promissory note / share redemption Hybrid

20. John buys $1,000,000 of insurance on Mary’s life Mary buys $1,000,000 of insurance on John’s life Agreement Premiums 50% XYZ Inc. Criss-cross with personally owned insurance Alternative 1.

21. John dies Alternative 1. Criss-cross with personally owned insurance

22. $1,000,000 Death Benefit 1 Mary $1,000,000 To purchase shares 2 John’s estate As per Buy/Sell returns shares to Mary 3 Criss-cross with personally owned insurance Alternative 1.

23. Tax Implications – John *Exemptions may help shelter

24. Tax Implications – Mary

25. Alternative 1. Criss-cross with personally owned insurance Taxation 1.Premiums paid with after-tax dollars by owners 2.Any capital gains on “sold” shares belong to the deceased’s estate Advantages 1.The simplest of all alternatives 2.Surviving owner(s) have an increased ACB 3.Insurance proceeds protected from claims of any corporate creditors Disadvantages 1.Large number of policies to maintain if there are multiple owners 2.Dealing with policies could be a problem in the event of disagreement 3.Premiums are paid with individual after-tax dollars

26. XYZ Inc. buys $1,000,000 of life insurance on John’s life and $1,000,000 of life insurance on Mary’s life Agreement Premiums 50% XYZ Inc. Criss cross with corporate owned insurance Alternative 2.

27. John dies Alternative 2. Criss-cross with corporate owned insurance

28. $1,000,000 Promissory note To purchase shares 2 John’s estate Mary $1,000,000 Death Benefit 1 XYZ Inc. As per Buy/Sell returns shares to Mary 3 XYZ Inc. declares a capital dividend of $1,000,000 4 Criss-cross with corporate owned insurance Alternative 2. Mary Now owns 100% of XYZ Inc. 5 $1,000,000

29. Tax Implications – John *Exemptions may help shelter

30. Tax Implications – Mary

31. Alternative 2. Taxation 1.Premiums paid by corporation are a non-deductible expense 2.Proceeds received by the company are tax-free 3.Proceeds in excess of ACB are credited to the CDA 4.Any capital gains on “sold” shares belong to deceased’s estate Advantages 1.After-tax premium cheaper if the company is in a lower tax bracket 2.Fewer policies are required (one per shareholder) 3.Premium disparities are not an issue 4.Surviving owner(s) have an increased ACB equal to the purchase price of the newly acquired shares Disadvantages 1.Insurance proceeds subject to claims from company’s creditors Criss-cross with corporate owned insurance

35. XYZ Inc. buys $1,000,000 of life insurance on John’s life and $1,000,000 of life insurance on Mary’s life Agreement Premiums 50% XYZ Inc. Share redemption with corporate owned insurance Alternative 3.

36. John dies Alternative 3. Share redemption with corporate owned insurance

37. $1,000,000 Death Benefit 1 XYZ Inc. $1,000,000 To purchase shares 2 John’s estate As per Buy/Sell, returns shares XYZ Inc. For cancellation 3 Share redemption with corporate owned insurance Alternative 3.

38. Mary now owns 100% of XYZ Inc. Alternative 3. Share redemption with corporate owned insurance

39. Tax Implications – John *Exemptions may help shelter

40. Tax Implications – John’s Estate

41. *Exemptions may help shelter Tax Implications – Mary

42. Taxation 1.Premiums paid by corporation are a non-deductible expense 2.Proceeds received by the company are tax-free 3.Proceeds in excess of ACB are credited to the CDA 4.Proceeds received by the shareholder’s estate in excess of the PUC deemed a dividend. The dividend could be elected as a capital dividend Advantages 1.After-tax premium cheaper if the company is in a lower tax bracket 2.Fewer policies are required (one per shareholder) 3.Premium disparities are not an issue Disadvantages 1.No increase in the ACB for the surviving shareholder 2.Insurance proceeds subject to claims from the company’s creditors Share redemption with corporate owned insurance Alternative 3.

43. The insurance would be corporately owned but the agreement would allow flexibility in determining at death how many shares would be purchased by the surviving shareholders and how many shares will be redeemed by the corporation. Hybrid Method with corporate owned insurance Alternative 4.

44. XYZ Inc. Buys $1,000,000 of life insurance on John’s life and $1,000,000 of life insurance on Mary’s life Agreement Premiums 50% XYZ Inc. Hybrid Method with corporate owned insurance Alternative 4.

45. John dies Hybrid Method with corporate owned insurance Alternative 4.

46. $500,000 To purchase shares 2 John’s estate $500,000 Promissory note To purchase shares Mary 4 $1,000,000 Death Benefit 1 XYZ Inc. As per Buy Sell returns 50% of shares XYZ Inc. For cancellation 3 Mary Now owns 100% of XYZ Inc. As per Buy Sell returns 50% of shares to Mary 5 7 XYZ Inc. declares a capital dividend of $500,000 6 Hybrid Method with corporate owned insurance Alternative 4.

47. Tax Implications – John *Exemptions may help shelter

48. $500,000 of shares redeemed Tax Implications – John’s Estate

49. $500,000 of shares sold Tax Implications – John’s Estate

50. *Exemptions may help shelter Tax Implications – Mary

51. Alternative 4. Taxation 1.Premiums paid by corporation are a non-deductible expense 2.Proceeds received by the company are tax-free 3.Proceeds in excess of ACB are credited to the CDA 4.Proceeds received by the shareholder’s estate in excess of the PUC is deemed to be a dividend. The dividend could be elected as a capital dividend Advantages 1.After-tax premium expense may be cheaper if the company is in a lower tax bracket 2.Fewer policies are required (one per shareholder) 3.Premium disparities are not an issue 4.Surviving shareholder gets an ACB step up Disadvantages 1.The insurance proceeds could be subject to claims from the company’s creditors 2.Somewhat complicated arrangement Hybrid Method with corporate owned insurance

52. Comparing the four strategies Results for each of the relevant parties

53. Tax Implications – John *Exemptions may help shelter Alternative 1. Alternative 2. Alternative 3. Alternative 4.

54. Tax Implications – John’s Estate Alternative 1. Alternative 2. Alternative 3. Alternative 4.

55. *Exemptions may help shelter Tax Implications – Mary Alternative 1. Alternative 2. Alternative 3. Alternative 4.

56. Total Tax Payable Alternative 1. Alternative 2. Alternative 3. Alternative 4.

57. Summary All four strategies have pros and cons As with all planning, the client’s legal, tax and accounting professionals should be consulted as to the most appropriate strategy for the client

58. Buy/Sell Agreements