What Is a Buy-Sell Agreement?

A buy-sell agreement (also called a shareholder agreement or partnership buyout agreement) is a legally binding contract between co-owners of a business that outlines what happens to an owner’s shares if they die, become disabled, or exit the business.

Without one, a deceased owner’s shares could pass to their spouse or estate — leaving the surviving business owner in a partnership with someone who has no interest or ability to run the company. A buy-sell agreement prevents this by establishing a clear process for transferring ownership and setting a pre-agreed price.

Why Fund It with Life Insurance?

A buy-sell agreement is only as good as the funding behind it. If a co-owner dies and the surviving partner needs to buy out their shares, where does that money come from?

Without life insurance, the options are limited — and painful:

• Drawing down business savings

• Taking on personal or business debt

• Selling business assets at a loss

• Bringing in outside investors on unfavourable terms

Life insurance solves this problem cleanly. When a co-owner dies, the insurance proceeds provide the surviving owner with the exact capital needed to purchase the deceased owner’s shares — without debt, delays, or distress.

How Does a Life Insurance-Funded Buy-Sell Agreement Work in Canada?

There are two main structures used in Canada:

1. Criss-Cross (Cross-Purchase) Structure

Each business owner takes out a life insurance policy on the other owner(s). When one owner dies, the surviving owner receives the death benefit and uses it to purchase the deceased’s shares from their estate.

This structure works well for smaller partnerships with two or three owners.

2. Corporate-Owned (Redemption) Structure

The corporation owns and pays premiums on life insurance policies for each owner. When an owner dies, the corporation receives the death benefit and uses it to redeem (buy back) the deceased owner’s shares directly.

The death benefit flows through the Capital Dividend Account (CDA), allowing the corporation to pay out tax-free dividends to the estate — making this a highly tax-efficient approach for incorporated Canadian businesses.

Key Benefits of a Life Insurance-Funded Buy-Sell Agreement

• Business continuity — surviving owners maintain control without unwanted new partners

• Family protection — the deceased owner’s family receives fair market value for their shares promptly

• Tax efficiency — corporate-owned structures can leverage the Capital Dividend Account for tax-free distributions

• Pre-agreed valuation — eliminates disputes over share price at the worst possible time

• Lender confidence — banks and investors take comfort knowing the business has a continuity strategy in place

What Happens Without a Buy-Sell Agreement?

Without a funded agreement in place, business owners face:

• Surviving owners being forced into partnership with a deceased owner’s spouse or estate

• Lengthy, expensive legal disputes over share valuation

• Forced sale of the business at a discount to raise buyout capital

• Loss of key business relationships during an already difficult transition

For many Canadian small and medium businesses, the absence of a buy-sell agreement is the single biggest threat to long-term continuity.

How Life Insurance Valuation Works

The buy-sell agreement should specify how the business will be valued at the time of a triggering event. Common methods include:

• Fixed price — owners agree on a set dollar value, reviewed annually

• Formula-based — a predetermined formula (e.g., multiple of EBITDA) determines the price

• Independent appraisal — a third-party valuator is engaged at the time of the event

The life insurance coverage amount should reflect the current business valuation and be reviewed regularly as the business grows.

Who Should Have a Buy-Sell Agreement?

Any Canadian business with two or more co-owners should have a funded buy-sell agreement in place. This includes:

• Incorporated small businesses with multiple shareholders

• Professional corporations (medical, legal, dental practices)

• Family businesses with multiple family members as co-owners

• Partnerships where one owner’s death would significantly impact operations