What Happens to Your Business If Something Happens to You?

In a 2023 report from the Canadian Federation of Independent Business (CFIB), 39% of small business owners said their business was too reliant on them for day-to-day operations. Only 9% had a formal succession plan in place.

Most succession conversations are about retirement, which makes sense because that’s the exit most owners are planning for. But the same questions apply if an owner or a key employee dies or becomes too sick to work unexpectedly, and in that case there’s no runway to figure things out. That’s where key person and buy-sell insurance come in.

Two related but different problems

It helps to separate two questions that often get lumped together. The first is operational: if the person most of the clients call first is suddenly gone, can the business keep running while it adjusts? The second is about ownership. If one of several owners dies, who ends up with their share, and how does everyone get paid fairly?

Key person insurance is built for the first question. Buy-sell insurance is built for the second.

Key person insurance

RBC Insurance describes a key person as an owner or employee whose skills and knowledge are valuable enough that the business would suffer substantial financial losses if they died or couldn’t work. In a smaller company, that’s very often the owner.

With key person coverage, the business owns the policy and receives the benefit. Canada Life, one of the carriers we work with, notes it can be set up as life insurance, critical illness insurance, or disability insurance, depending on which event the business wants protection against. The money can help cover the cost of hiring and training a replacement, and it keeps debts and expenses paid while the business finds its footing (which also goes a long way toward reassuring lenders and clients).

Buy-sell insurance

Many businesses with more than one owner already have a buy-sell agreement, often written into the shareholder agreement. It spells out what happens to an owner’s share if they die, become disabled, or leave.

What’s easy to miss is that the agreement sets the terms but doesn’t necessarily provide the money. As Sun Life points out, a buy-sell agreement may only outline how a sale works, and if the surviving owners don’t have the full value of their partner’s share sitting in personal savings, they may not be able to complete the purchase when the time comes.

Life or disability insurance can fill that gap. The benefit gives the remaining owners the cash to buy out the departing owner’s share, so they don’t have to drain personal savings or pull money out of the business to do it. It also matters for the family on the other side of the deal, who receive fair value for the share instead of being left holding part of a business they may have no role in.

The policies can be structured a few ways. According to RBC, each owner can hold a policy on the other owners (called a cross-purchase arrangement), or the business itself can own the policies. Which approach fits depends on the number of owners and how the agreement is written, and it’s a decision worth making together with your accountant and lawyer.

A note on how the money is taxed

Life insurance death benefits are generally received tax-free. When a private corporation is the beneficiary, the Canada Revenue Agency allows the proceeds, less the policy’s adjusted cost basis, to be added to the corporation’s capital dividend account, which can then be used to pay tax-free capital dividends to shareholders. The details depend on how the policy and the corporation are set up, so this is one area where coordinating with your accountant pays off.

Worth a second look, even if you’ve already planned for it

If your business already has an agreement and coverage in place, it may still be worth reviewing. As a business grows, a policy amount that matched the value of a share when it was set up may not match it anymore. An agreement that was never funded, or was funded years ago and never revisited, can leave the people involved in a harder spot than anyone intended.

If you’d like to walk through what’s in place for your business and whether it still fits, you can book a meeting with us and we’ll help you think it through.

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