Business Continuity Planning
Keyperson Protection
Funding Shareholder Agreements
Global Financial
2007 Kick-Off Meeting
Wednesday, January 10, 2007
Presented by: Tom Pilkington CA CFP TEP
National Estate and Tax Planning Consultant
Ontario Regional Marketing Centre
Important considerations
This material is for information purposes only and should not be
construed as legal or tax advice. Every effort has been made to
ensure its accuracy, but errors and omissions are possible.
All comments related to taxation are general in nature and are
based on current Canadian tax legislation for Canadian
residents, which is subject to change. Persons who are not
residents in Canada or who are resident in Canada but are
citizens of another country, may be subject to different tax
rules in Canada and may also be subject to taxes levied by
jurisdictions other than Canada.
For individual circumstances, consult with legal or tax
professionals.
This information is current as of January 10, 2007
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Agenda
Business continuity planning
Keyperson protection
Funding shareholder agreements
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Keyperson Protection
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The success of a business
The right strategy
The right product / service
The right market
The right price
The right people!
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Who are the key employees
Key decision makers
Financial and operations management
Research
Technology
Marketing
Sales
Etc.
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Who are the key employees
The owner-managers
Any other employees who have a financial
impact on the success of the business
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The problem
Premature death of the owner-manager or
other key employee:
Bankers may call loans
Suppliers may not extend credit
Customers may not return
Employees may seek more secure employment
Without a source of working capital, the
business may not survive!
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The problem
The business will need cash to
Meet immediate working capital needs
Repay short-term loans
Hire interim management
Find, attract, hire and train a replacement
But, where will the cash come from?
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The solution
Business earnings?
The bank?
Family?
Friends?
Investors?
Life insurance!
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Key person insurance protection
Planning considerations
Type of policy
Life insured
Owner
Beneficiary
Premium payer
Premiums are not tax deductible
Death benefit is tax-free
Credit to CDA
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Prospect profile
Private corporation (small or large)
Closely held
Owner-manager or other key employees
Age 30 - 50, healthy
Cash flow to pay premiums
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Factfinding
Are you able to take regular vacations away
from the business?
Are other family members involved in the
business?
Is the business protected for the loss of your
key employees?
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Funding Shareholders Agreements
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The problem
What happens to the shares of a deceased
shareholder if there is no prior arrangement
Mr. A Ms. B Mr. C
OPCO
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The problem
Shares pass through the deceased’s estate to
the surviving spouse / kids / other
beneficiaries, who then become owners in
the business
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The problem
What problems might arise if the deceased’s
family gets the shares
On-going tensions with other owners
Family may wish to sell the shares
Family may not be able to find a buyer
Other owners may wish to purchase the shares
Family and other owners may not be able to
agree on price
Other owners may not have sufficient funds to
purchase the shares
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The problem
Typically, the deceased’s estate would
prefer having cash and not shares
Typically the remaining shareholders would
prefer owning all the shares and having full
control of the company
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The solution
Owners enter into a shareholders agreement
Contractual undertaking under which each
shareholder assumes certain rights and
obligations
One of the most important business tools
Objective is to minimize shareholder disputes
Includes buy-sell provisions to help ensure an
orderly transition in the event of the withdrawal
of a shareholder for any reason
Pre-funded if possible to reduce financial risk
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Events covered in an agreement
Dissension between the parties
Third party offers
Marital breakdown
Insolvency
Retirement
Disability and/or critical illness
Death
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Funding the buy-sell provisions
Funding alternatives
Defer the funding obligation until event occurs
- Use corporate or personal cash flow
- Use corporate or personal assets
- Use bank loans
- Use vendor financing
Pre-fund the obligation
- Sinking fund (reserve)
- Insurance
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Structuring an insured buy-sell
Structuring an insured buy-sell
Alternatives:
Insured cross-purchase method
Insured promissory note method
Insured share redemption method
Insured hybrid (combination) method
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Structuring an insured buy-sell
Structuring an insured buy-sell
Insured cross-purchase method
- Insurance is personally owned (or by trust)
- Deceased’s shares are purchased by surviving
shareholders
- Purchase is financed with life insurance proceeds
- Capital gain taxed on deceased’s final tax return
- Capital gains exemption may be available
- Step-up in ACB of survivor’s shares
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Structuring an insured buy-sell
Structuring an insured buy-sell
Insured promissory note method
- Insurance is corporate owned
- Deceased’s shares are purchased by surviving
shareholders
- Purchase is financed with life insurance proceeds
- Capital gain taxed on deceased’s final tax return
- Capital gains exemption may be available
- Step-up in ACB of survivor’s shares
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Structuring an insured buy-sell
Structuring an insured buy-sell
Insured share redemption method
- Insurance is corporate owned
- Deceased’s shares are redeemed (purchased) by
the company
- Purchase is financed with life insurance proceeds
- Capital gain on deceased’s final return offset by
capital loss in estate
- Deemed dividend on redemption elected to be a
tax-free capital dividend
- No step-up in ACB of survivor’s shares
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Structuring an insured buy-sell
Structuring an insured buy-sell
Insured hybrid (combination) method
- Insurance is corporate owned
- Portion of deceased’s shares purchased by surviving
shareholders under the insured promissory note
method and remaining shares are redeemed under
the insured share redemption method
- Purchase is financed with life insurance proceeds
- Permits use of capital gains exemption
- Partial step-up in ACB of survivor’s shares
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Choice of method
FMV of business
ACB of shares
Availability of capital gains exemption
Number of shareholders
Relative cost of coverage
Personal vs corporate tax rate
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Case study
Smith Jones
FMV = $500,000 FMV = $500,000
50 ACB = $0 ACB = $0 50
Shares PUC = $0 PUC = $0 Shares
OPCO
Fair Market Value = $1,000,000
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Case study
Solution (in this case study)
Insured promissory note method
- $500,000 life insurance coverage on each owner (at
least!)
- Opco owns the policy, pays premiums and is the
beneficiary
- Premiums are not tax deductible!
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Case study
Steps
Insured promissory note method
- $500,000 life insurance pays tax-free death benefit
to Opco following death of shareholder
- Excess of proceeds over policy ACB credited to
capital dividend account
- Survivor purchases shares from deceased’s estate in
return for promissory note
- Opco distributes insurance proceeds to survivor as
tax-free capital dividend
- Survivor uses cash to pay off the promissory note
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Case study
Result
Insured promissory note method
- Deemed disposition on death results in $500,000
capital gain on the deceased’s final tax return
- Capital gain fully offset by capital gains exemption
- Deceased estate receives $500,000 proceeds on sale
tax free!
- Survivor now owns 100% of shares worth $1,000,000
with a tax cost (ACB) of $500,000 and incurs no
debt on the transaction!
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Questions?
Thank You!
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