Funding a Buy-Sell Agreement

A buy-sell agreement is funded by deciding, before anyone leaves, where the money will come from when the other shareholders are obliged to buy. For a death, the money can come from life insurance owned by the shareholders personally or by the corporation. For a retirement, a disability or a dispute, it comes from cash the company has kept, credit arranged before it is needed, coverage written for that event, or instalments paid to the departing shareholder or the estate. The agreement comes first, and the funding is shaped to fit it.

Two people own a company in equal shares, and each assumes the other will still be there next year. That holds for years, and then one of them dies, falls ill, retires, separates or wants out. On that day somebody new has a claim on half the company, and it may be an estate that has never worked in the business and needs to be paid. The document decides what happens next. The money decides whether it can happen.

What is a buy-sell agreement, and what does it have to settle?

A buy-sell agreement is the contract among shareholders that decides what happens to a departing shareholder's shares. In a Canadian private company it can be a separate document or a set of clauses inside the shareholders' agreement. Either way, it has six things to settle:

• The triggers: the events that start the purchase.
• The buyer: the other shareholders, the corporation, or a mix of the two.
• The price: a fixed figure, a formula, or a valuation by a named method.
• The timeline: how long the buyer has to pay, and on what terms.
• What the departing shareholder or the estate receives, and when.
• The funding: where the money comes from.

Death is the trigger everybody remembers. Permanent disability, the diagnosis of a listed illness, retirement at a stated age, a separation that puts a spouse's claim on the shares in play, and a shareholder who simply wants out are departures too. An agreement written only for death has covered the one event that life insurance can fund and left the others open.

Price is a clause that ages quickly. A fixed figure written in at signing goes stale as the company grows, and a formula tied to earnings or book value can still produce a number nobody accepts years later. Some agreements name a valuation method and a business valuator instead, so the figure is set when it is needed. Whatever the method, the funding has to be sized to what it produces today, not to what it produced at signing.

The next choice is whether the purchase is an obligation or an option. A mandatory purchase binds the buyer and gives the estate certainty. An option, either a right to buy (a call) or a right to require a purchase (a put), leaves each side free to decide later, and it can change the tax result for the estate when a spouse inherits the shares. The lawyer drafts that choice with the accountant.

Who writes the agreement, and why does it come first?

A lawyer writes it, or a lawyer or notary in Quebec, with the corporation's accountant involved in the price mechanism and the tax. It comes first because funding answers a question the agreement asks. Until the trigger, the buyer, the price and the timeline are on paper, there is no obligation to size, no date to fund against, and nothing to tell the money what it is for.

A contract bought before those terms exist is a sum of money with no instructions. The drafting meeting is also the right moment to ask the awkward questions, while everybody is healthy and on good terms: what counts as a departure, who must buy and who merely may, how long the buyer has to pay, and what happens if the buyer cannot. Those answers cost little in a boardroom and a great deal in a courtroom.

The roles stay separate. The firm behind this site does not draft agreements and does not give tax or legal advice, and it is paid by insurer commission if a policy is bought. What a licensed insurance representative can do is describe how an obligation of a stated size, payable on a stated event, can be funded with insurance, show what a contract guarantees and what it does not, and hand the file back to the lawyer and the accountant who decide. Ask any representative you meet how they are paid.

What are the ways to fund a buyout, and which events does each cover?

There are six ordinary sources of money for a buyout, and they are not interchangeable. Each answers some triggers and not others. The table describes what each one does. It ranks nothing, and the right mix depends on the agreement, the company and the people in it.

Cash kept in the corporation needs a caution of its own. Profit retained in a Canadian-controlled private corporation is taxed under rules the accountant applies before anything is set aside: the small business deduction and its business limit, the reduction of that limit when the corporation earns enough investment income (the passive income rules), the personal services business rules where they apply, and, in Quebec, the paid-hours condition on the provincial small business deduction. A reserve that is invested earns investment income under those rules. That is a reason to plan the reserve with the accountant, not a reason to avoid one.

For the insurance rows, the figures that matter come from the issued contract and a dated illustration from the insurer: the required premiums and for how long, the guaranteed death benefit and cash surrender values year by year, the illustrated values and the assumptions behind them, and what the contract allows if premiums stop. Coverage that protects the company itself against the loss of a person does a different job, explained on key person coverage.

Whatever the mix, a binding purchase obligation needs a credible way to pay, whether insurance, cash set aside, agreed instalments or credit whose availability has been tested. An obligation with none of them attached is a promise, not a plan.

What happens when an obligation has no funding attached?

The obligation survives, and the money has to be found somewhere else at the worst possible time. A clause saying the surviving shareholders shall buy a deceased shareholder's shares at fair market value within one hundred and twenty days reads the same whether the money exists or not.

Credit is the first place people look, and it is assessed under pressure. A lender looks at a company whose shareholder has died, whose revenue may have depended on that person, and whose remaining owner now wants to borrow a large sum to pay an estate. The application is decided on the numbers and conditions of that year, and it may be approved, priced higher or declined.

Paying the estate over time is the second route. Unless the agreement already provides for instalments, it depends on the estate agreeing to wait, and an executor (called a liquidator in Quebec) who has to settle the estate and pay its debts may resist. The estate then carries the company's risk until the last payment, which is why instalment terms carry interest and security. A shareholder who has just bought in carries this obligation from the first week, which is part of what is signed in partnership buy-in and the year of highest debt.

The third route is to renegotiate everything with people who have just come from a funeral. Each route is lawful. Each is slower, and more likely to end in a dispute, than funding arranged while everybody was healthy and on good terms.

Term or permanent coverage: what does each do for a buy-sell?

Term insurance covers a set period, such as a number of years or to a stated age. It pays the death benefit if the person insured dies within the term and pays nothing after it ends. Depending on the contract, it may be renewable at premiums that rise with age, and convertible to permanent coverage without new medical evidence within a period the contract sets. Term matches an obligation with a foreseeable end, for example where the owners expect to sell or retire within the term.

Permanent insurance, including participating whole life, covers the person insured for life as long as premiums are paid as the contract requires. Its premium is generally higher at the outset than term for the same death benefit, and it builds a cash surrender value. Permanent coverage matches an obligation with no end date, such as an agreement meant to run as long as the shareholders own the company. The cash surrender value is not a separate fund. Drawing on it, through a policy loan from the insurer or a withdrawal, reduces what the contract pays at death and can produce tax under the policy rules.

Some agreements use both, for example term for part of the amount, or term that is converted later. The choice depends on how long the obligation will last, what the premium costs in the years the company is weakest, and what each contract guarantees. Before choosing, put these questions to the insurer in writing:

• What is the guaranteed death benefit, and what premium is required each year, and for how long?
• What are the guaranteed cash surrender values year by year, and which values are only illustrated?
• What assumptions does the illustration use, and what does it show at a lower dividend scale?
• Can the term contract be renewed or converted, until what age, and on what terms?
• What happens if a premium is missed, and what options does the contract give if premiums stop?
• What documents will the insurer need to pay a death claim?

How does the criss-cross structure work?

Each shareholder personally owns a contract on the life of each other shareholder, pays its premium and is its beneficiary. On a death, the insurer pays the surviving shareholder, who uses the money to buy the deceased shareholder's shares from the estate. The money does not pass through the corporation.

Who owes whom is simple. The survivor owes the estate the price the agreement sets, and the death benefit pays that debt. The corporation is not a party to the purchase, and the proceeds are paid to the survivor personally, outside the corporation's balance sheet and away from the claims of its creditors.

A death benefit paid to a named beneficiary is generally received without income tax. The price the survivor pays becomes part of the survivor's cost of the shares. Where the new shares are identical to shares the survivor already owns, subsection 47(1) of the Income Tax Act averages the cost: the old cost and the new price are added together and spread across all the identical shares the survivor holds after the purchase. Shares of different classes are calculated separately, and the accountant confirms the actual classes and costs.

The premiums are paid with personal after-tax money. For an owner who draws salary or dividends from the company, that money has been taxed once on the way out. Premiums differ with age and health, so the shareholders pay different amounts for each other's coverage, and some agreements add a clause to share that difference. Each time a shareholder joins or leaves, contracts have to be added, transferred or ended.

How does the corporate-owned structure work, and what is the promissory note route?

The corporation applies for, owns, pays for and is the beneficiary of a contract on each shareholder's life. On a death, the insurer pays the corporation. What happens next depends on how the agreement is drafted. The corporation can redeem the deceased shareholder's shares, or the surviving shareholders can buy them and the corporation can help them pay through a capital dividend. One contract per shareholder covers the arrangement however many owners there are, which is part of its appeal. The general mechanics are on corporate-owned life insurance.

The premiums are paid with corporate money, which for a company taxed at the small business rate is a different pool from personal after-tax income. Premiums are generally not deductible. Paragraph 20(1)(e.2) of the Income Tax Act allows a limited deduction where an interest in the policy is assigned to a restricted financial institution in the course of borrowing from it, the interest on that borrowing is deductible, and the institution requires the assignment as collateral. The deduction is then the least of the premium, the net cost of pure insurance for the year and the part that can reasonably be related to the amount owing. That is our reading, and the accountant applies it; more on which part of a premium can be deductible, and on fitting premiums to the company's cash flow in funding premiums from corporate cash flow.

In the promissory note route, the steps run in this order:

1. The surviving shareholders buy the deceased shareholder's shares from the estate and give the estate a promissory note for the price the agreement sets.
2. The insurer pays the death benefit to the corporation once the claim is approved.
3. The corporation's capital dividend account is credited with the proceeds less the policy's adjusted cost basis immediately before the death.
4. The corporation elects under subsection 83(2) and pays a capital dividend to its shareholders, who are now the survivors.
5. The survivors use the capital dividend to pay the note. Any part of the price the dividend does not cover is paid from other money, on the terms of the note.

The survivors owe the estate. The corporation owes nobody: it pays a dividend to its own shareholders. Lending the money to the survivors instead would make them debtors of the corporation, and a loan from a corporation to a shareholder has tax rules of its own that the accountant would then have to manage. The dividend route avoids that question, and the accountant confirms it on the facts.

Against those features, the proceeds land inside the company, where its creditors can reach them until they are paid out, and the cash surrender value of a permanent contract is a corporate asset in the meantime. That asset matters for the capital gains exemption tests.

What do the adjusted cost basis and the capital dividend account do?

The adjusted cost basis is a tax figure for the policy, defined in subsection 148(9) of the Income Tax Act. Premiums add to it and the cost of the insurance inside the contract reduces it, so it changes over the years and can fall to zero. It matters here because it is subtracted from the death benefit in the next step.

For a private corporation, paragraph (d) of the definition of the capital dividend account in subsection 89(1) adds the proceeds of a life insurance policy received by the corporation because of a death, less the adjusted cost basis of the policyholder's interest immediately before the death. An insurer policy loan outstanding at the death reduces what the corporation receives. The account holds no money. It is a running tax record of what the corporation may pay out as capital dividends.

Paying it out takes an election. Under subsection 83(2), the corporation elects for the full amount of the dividend, in the prescribed form, at or before the time the dividend becomes payable, or the first day any part of it is paid if that is earlier. The federal form is T2054, and a Quebec corporation also files Revenu Québec form CO-502. A properly elected capital dividend is not included in a Canadian-resident shareholder's income. Electing more than the balance attracts a special tax under subsection 184(2), and a shareholder who lives outside Canada generally pays Canadian withholding tax on the dividend.

Illustrative example. Assume two shareholders each own half of a company, and the agreement prices the deceased shareholder's half at $1,000,000. The corporation owns a $1,000,000 policy on that shareholder's life and is its beneficiary. Immediately before the death, the insurer reports an adjusted cost basis of $80,000, and no policy loan is outstanding. The credit to the capital dividend account is $1,000,000 less $80,000, or $920,000. The survivor buys the shares for a $1,000,000 note and becomes the only shareholder. The corporation elects and pays a $920,000 capital dividend, which the survivor applies to the note. That leaves $80,000 of the price owing to the estate, to be paid from other money on the terms of the note. The figures are assumptions for the arithmetic only, and the account's other entries, which the accountant tracks, are left out.

The full reference is on the capital dividend account, and the filing after a death, step by step, on paying a capital dividend after a death.

Redemption or purchase by the survivors: how does the tax differ?

A redemption is the corporation buying back and cancelling the deceased shareholder's shares, so the estate deals with the corporation. A purchase is the surviving shareholders buying those shares personally, so the estate deals with them. Both start from the same event. Under subsection 70(5) of the Income Tax Act, a person is deemed to have disposed of each capital property immediately before death, at fair market value, and shares of a private company are capital property. The deceased's final return reports a capital gain only to the extent that value exceeds the adjusted cost base of the shares.

A tax-deferred rollover to a surviving spouse or common-law partner, or to a qualifying spousal trust, is available under subsection 70(6) only if the shares become vested indefeasibly in the spouse or trust within 36 months after the death, or a longer period the Minister considers reasonable on a written application. In our reading, an agreement that obliges the estate to sell the shares to someone else can stand in the way of that condition. Some agreements use options, a put and a call, instead of a binding obligation for that reason. Plan on the deemed disposition applying unless the lawyer drafts otherwise and the accountant confirms the result.

In a purchase by the survivors, the estate sells the shares at the agreed price. The gain from the deemed disposition sits on the deceased's final return, and the accountant checks whether the shares qualify for the lifetime capital gains exemption and how much of the deceased's exemption remains. In a redemption, the corporation pays the estate. Under subsection 84(3), the amount it pays above the paid-up capital of those shares is deemed to be a dividend, and part of it can be elected as a capital dividend if the corporation has a balance. The estate can then also realise a capital loss on the redeemed shares, because its cost of the shares follows from the deemed disposition at death.

That loss can be carried back. As the Canada Revenue Agency explains on net capital losses for someone who died, the legal representative can elect to treat losses of the graduated rate estate as losses of the deceased on the final return, for losses in the estate's first tax year, or its first three tax years if the death was after August 11, 2024. The stop-loss rules of the Income Tax Act can reduce that loss where the estate received dividends on the shares, capital dividends included, subject to exceptions the accountant applies. These rules interact, which is why the accountant models the redemption, the purchase and any mix of the two before the agreement is signed.

Agreements sometimes give the corporation a first right to redeem part of the shares and the survivors a right to buy the rest. That hybrid has to be drafted and modelled, never assumed, by a lawyer and an accountant reading the real share register, the real paid-up capital and the real position of the estate.

When is the estate's tax due, and how does it fit the buyout deadline?

The deemed disposition is reported on the deceased's final return. On the Canada Revenue Agency page on filing and payment due dates for someone who died, modified 20 January 2026, the final return is due April 30 of the year after the death for a death between January 1 and October 31, and six months after the death for a death between November 1 and December 31. Where the deceased or their spouse or common-law partner carried on a business, it is due June 15 of the year after the death for a death between January 1 and December 15, and six months after the death for a death between December 16 and December 31.

Any balance owing still has to be paid by the payment due date. Part of the tax on certain returns can be deferred: the legal representative files Form T2075, the election to defer payment of income tax under subsection 159(5), and gives the agency acceptable security for the amount owing. Whether that helps depends on the estate, and the accountant decides it with the executor.

So the estate has two dates that need not fall together: the purchase date in the agreement and the tax date. Quebec residents also deal with Revenu Québec. The accountant maps both, and the payment schedule is written knowing them.

What does a life insurance contract do here, and what does it not do?

It pays the death benefit in force at the death of the person insured, without a lender's approval and without a sale of anything. It does not pay on the date of the death. The beneficiary makes a claim, and the insurer pays once its requirements are met, which can include a claim form and a death certificate, as the Financial Consumer Agency of Canada notes on making an insurance claim. Write the agreement's payment date to allow for the claim, and say how any obligation in the meantime is met. The steps are on how a death claim is paid in Canada.

In a participating whole life contract, the death benefit in force is the guaranteed base amount plus any paid-up additions bought with dividends, less any policy loan and any unpaid premium. Dividends are declared at the insurer's discretion from the results of its participating account. They are not guaranteed, and they have nothing to do with your company's value. A death benefit set at signing does not follow the share value. If the shares grow faster than the coverage, the gap is closed only by buying more coverage, which means new underwriting.

Now the limits. The contract has to exist before it can do anything, which means an application, medical underwriting and a decision no one can hurry once a shareholder is ill. It funds one trigger. The premium is payable every year whether or not the event happens, and a contract allowed to lapse funds nothing. It is insurance, not an investment.

What stands behind it is the issuing insurer's contractual promise and its solvency. Solvency is supervised by charter: by OSFI for a federally incorporated insurer, and by the home province for a provincially incorporated one, through the AMF in Quebec. Every life insurer authorized in Canada must belong to Assuris. For a whole life policy, as read on assuris.ca on 1 October 2026, Assuris protects up to $1,000,000 or 90% of the death benefit, whichever is higher, and up to $100,000 or 90% of the cash value, whichever is higher, calculated on the net values after policy loans. A buy-sell death benefit can be larger than the protected amount.

What does a corporate-owned policy do to the capital gains exemption?

The lifetime capital gains exemption applies to qualified small business corporation shares. The Canada Revenue Agency's guide T4037, Capital Gains 2025, modified 11 February 2026, sets three conditions. At the time of sale, the share is a share of a small business corporation, a Canadian-controlled private corporation with 90% or more of the fair market value of its assets used mainly in an active business carried on primarily in Canada, or in shares or debts of connected small business corporations. Throughout the 24 months before the sale, more than 50% of that value was in those categories. And throughout those 24 months, only you, a partnership of which you were a member or a related person owned the share.

A policy is generally not an asset used in the business. For these tests, subsection 110.6(15) of the Income Tax Act deems the fair market value of a life insurance policy, at any time before the death of the person insured, to be its cash surrender value. A growing cash surrender value inside the operating company can therefore weigh against the asset tests. The same subsection has a separate rule for the period after a death, when the proceeds are used to redeem or buy shares. That is our reading of the text, and the accountant applies it to your balance sheet.

This is a different question from the passive income rules. In our reading, growth that stays inside an exempt policy is not taxed as it builds, while a surrender, a policy loan above the adjusted cost basis, or dividends paid out in cash can produce income in the corporation. How any of those interacts with the small business deduction is the accountant's calculation. The wider exit questions are on an exit in ten years.

What changes with more than two shareholders, a trust or a holding company?

With two owners in a criss-cross, each holds one contract on the other. With four owners, each holds three, which makes twelve contracts, and every admission or departure re-papers the set. That is the point where owners look at a trustee holding the contracts for everyone, or at corporate ownership.

Under a trustee arrangement, the trustee owns a contract on each shareholder's life and is its beneficiary, holds the contracts under a trust deed drafted with the shareholders' agreement, collects the proceeds on a death and applies them as the agreement directs. It buys administrative order at the cost of another document and a trustee who must still be there in twenty years. In Quebec, a common law bare trust cannot be assumed to work: the Civil Code has its own trust rules, and a Quebec notary or lawyer designs any trust. Wherever you are, proceeds paid to a trustee are not received by the corporation, so in our reading they do not create a capital dividend account credit. The accountant tests the tax treatment of the whole arrangement.

Where a shareholder holds the shares through a holding company, the holding company is the shareholder, the seller and possibly the buyer. That changes who owns each policy, who pays for it and who receives the money. The capital dividend account credit arises in whichever corporation receives the proceeds, and a capital dividend paid by an operating company to a holding company adds to the holding company's own account. A premium paid by one company on a policy that another company or a shareholder owns can raise a taxable benefit question. Which entity should own, pay for and be the beneficiary of each policy has no default answer; settle it with the accountant and the lawyer or notary before applying. More on the holding company and where the contract sits.

When a shareholder leaves alive, the policies on that person's life have to be dealt with too. Depending on the agreement, the owner keeps the contract, surrenders it or transfers it, for example to the departing shareholder. A transfer of ownership is a disposition under the policy rules of section 148 of the Income Tax Act, with its own tax result for the person or company giving it up. The agreement should say what happens to each policy and at what price.

What funds a departure that is not a death?

Something other than life insurance, because a life contract funds one trigger. A shareholder who retires, resigns, separates or wants the capital back presents no insurable event. The agreement has to say how those departures are paid for, and the answers are cash kept in the company, a note paid over time, credit, or a mix of them.

Disability sits between the two. Coverage exists that pays a benefit when a shareholder becomes disabled as the contract defines it, and it can be tied to a buy-sell obligation the way life coverage is. Each contract sets its own definition, waiting period and payout options, which can include a lump sum or instalments. The agreement's definition of disability has to match the contract's, not the reverse, or the agreement can oblige a purchase the insurer will not fund.

A retirement asks the others to find real money out of real profits for a shareholder who is healthy and leaving on schedule. Agreements handle it with long notice periods, payment over several years with interest and security, and a price mechanism everyone accepted in advance. A cash reserve built for this purpose is planned with the accountant under the corporate tax rules.

The deadlock clause handles the rest. In a mutual buy-sell clause, sometimes called a shotgun clause, one shareholder names a price and the other chooses whether to buy or to sell at it. It produces a result without a judge. It is blunt, and it can favour the shareholder with readier access to cash, which is worth weighing before it goes into the agreement.

How often should coverage be checked against the agreement's price?

Once a year is the schedule we suggest, and it belongs in the agreement itself so it happens without anyone having to remember. A company keeps changing value, and a coverage amount stays where it was put. If the agreement's price rises and the coverage does not, the buyers have to find the difference elsewhere, on the one day the arrangement is used. Each review compares these figures, each from its own source:

1. The price the agreement's mechanism produces today, from the valuation the agreement names.
2. What each contract would pay at death today, from the insurer's current statement, net of any policy loan.
3. The gap between the two, which is what a buyer would have to find elsewhere.
4. Whether the shareholders, their holdings and their family situations are the same as last year.
5. Whether the owner, payer and beneficiary of each policy still match the agreement.

Increasing coverage later means new underwriting, at an older age and with whatever health history has built up in between, and it may mean a refusal or a higher premium. That is the argument for sizing the coverage to the price at the outset, as far as the premium can be carried through a weak year, and for reviewing it on schedule.

Who answers which question?

A buy-sell arrangement involves several professionals, and each answers different questions. Bringing the right question to the right person saves time and fees.

Ask each of them to answer in writing, and give each the same draft agreement, so the answers fit together.

Who this suits, and who it does not

Co-owned incorporated businesses should consider written rules for what happens when an owner dies or leaves. Whether that means a separate buy-sell agreement or clauses in an existing shareholders' agreement, and whether insurance funds any of it, depends on the share rights already in place, the owners and what they want.

Insurance funding suits owners who are insurable, whose company is meant to continue after one of them dies, and where the survivors want to own the whole of it. It suits companies where a forced sale or a long note would damage the business, and owners who would rather carry a premium every year than test the alternative. It fits more easily once the agreement is drafted, because the funding then has something real to attach to.

It suits less well owners who plan to sell within a few years, where the obligation is short-lived and term coverage or no insurance may fit better; a shareholder who is uninsurable, or whose premium the company cannot carry through a weak year; and a company with no surplus in a normal month. A policy is life insurance first. It is not the tool for a business need that is only a few years away, and it should not be bought for one.

The order does not change. The agreement first, drafted by a lawyer, or a lawyer or notary in Quebec, with the accountant on the price and the tax. The funding second, shaped by what the agreement obliges. The product last. The corporate structure underneath all of it, with its limits, is set out on the business owners page.