A buy-sell agreement is a legally binding contract between business co-owners that governs what happens to an owner's interest when a triggering event occurs. Think of it as a prenuptial agreement for business partners — nobody wants to need it, but having it in place protects everyone.
What is a buy-sell agreement?
A buy-sell agreement answers these fundamental questions in advance:
- If a partner dies, who buys their shares — and at what price?
- If a partner becomes disabled and can no longer contribute, what happens to their ownership?
- If a partner wants to exit, who has the right to buy them out and on what terms?
- How is the business valued for the purpose of these transactions?
- What happens if a partner files for bankruptcy or goes through a divorce?
Without these answers documented and agreed upon in advance, any of these events can lead to expensive legal disputes, forced business sales, or unwanted co-ownership situations.
Triggering events
Insurance provides the funding to purchase shares from the deceased's estate at fair market value.
Disability insurance or critical illness insurance funds a buyout if a partner is unable to work long-term.
Typically funded through the business's retained earnings or an installment payment structure.
Prevents a business partner's spouse from becoming a co-owner. Requires careful drafting.
Types of buy-sell structures
Cross-purchase agreement
Each owner buys and owns a life insurance policy on every other owner. When Owner A dies, Owner B uses the insurance proceeds to buy Owner A's shares from their estate. Simple and effective for 2-partner businesses, but becomes complex with 3+ owners (each would need policies on every other owner).
Corporate (redemption) agreement
The corporation owns and pays for insurance policies on all shareholders. On a triggering event, the corporation redeems (buys back) the departing owner's shares using the insurance proceeds. Works well for businesses with multiple shareholders. The death benefit flows through the Capital Dividend Account, potentially allowing a tax-free redemption.
Funding the buyout with insurance
A buy-sell agreement is only as good as the funding behind it. The most common and effective way to fund a business buyout is through life and disability insurance. Without insurance, partners may face these problems at exactly the wrong time:
- The surviving partner doesn't have $500,000–$2,000,000 in cash sitting around to buy out the deceased's estate
- The estate needs liquidity immediately but the business can only pay over 10 years — creating conflict
- A forced sale of the business to an outside buyer at a distressed price
- The deceased's spouse becomes an unwanted business partner
With insurance funding, the buyout occurs immediately, at full value, without disrupting the business's cash flow or operations.
Business valuation
Your buy-sell agreement must specify how the business will be valued when a triggering event occurs. Common methods:
- Fixed price: Owners agree on a price in advance (typically reviewed annually). Simple but can become outdated quickly.
- Formula: A formula based on revenue, EBITDA, or book value is specified. More objective but may not capture goodwill.
- Professional appraisal: An independent valuator is hired at the time of the triggering event. Most accurate but time-consuming and potentially contentious.
- Shotgun clause: Either partner can name a price; the other partner must either buy at that price or sell at that price. Creates fair pricing incentive.
Carrie's advice: A buy-sell agreement without funding is a legal document without teeth. And insurance funding without a buy-sell agreement leaves the proceeds without a clear direction. Both elements must exist together — and the insurance coverage must be reviewed whenever the business changes significantly in value or ownership structure.
Carrie Wang
Carrie is the founder of Seven Lakes Financial Services Inc. and a Sun Life advisor serving clients across Ontario and Saskatchewan. She specializes in retirement, estate, and investment planning, with a warm, personalized approach. She is fluent in English, Mandarin, and Taiwanese.