Sometime ago we were asked to work with a financial advisor to structure life insurance funding for three business owners. The business had been in the family for almost 100 years.

In 1991 the current owners put together a partnership agreement. To fund the agreement the company purchased $1 million of life insurance on each of the three partners. As is not unusual the business owners had the review of their business agreement as a low priority. They had an agreement and when they had time they would get around to reviewing the agreement.

All three worked long days to build the business. Build it up they did. Today it is worth more than $30 million.

In a twist of fate some years ago, one of the partners became uninsurable. So, increasing his coverage was out of the question. When we reviewed the agreement with their tax advisor the strategy was to place insurance on the two healthy partners and try to get some coverage that included the uninsurable partner. All to be done with hardly any interference with cash flow using the custom strategy Lengvari created in the early 1980s. The purpose is to provide life insurance but improve cash flow compared to buying “cheap” term insurance.

We started the process and a week after the applications were taken, the uninsurable partner died unexpectedly. Panic amongst the remaining two shareholders set in.

What was left was a seriously underfunded partnership agreement. When the will was read it was revealed that not only was it poorly drafted but made no mention of his shares in the company. Lots of bequests but no money. An impotent Will.

Soon after the funeral I met with the two remaining shareholders. The first question was, “How much insurance did he have?”

There was only a $1,000,000 life insurance taken out soon after the agreement was set up. But the company was short about $11,000,000 to fund a full repurchase of the shares by the corporation.

Not long after, on a cool dark evening, I delivered the $1,000,000 life insurance cheque. As we sat across from each other, the principal partner was in tears. He had lost a brother he loved dearly and now had to deal with the worry of having to keep the business afloat. “Where was the money going to come from?” he asked.

There wasn’t enough money to fund a full share repurchase from the estate under the terms of their agreement. The only solution, he thought was to sell an asset, go into substantial debt, or sell the business. All those options were unattractive and hardly financially viable. It didn’t fit with the long- term planning…to keep the business in the family.

Sitting across from a grown man reduced to tears is not easy. I felt for him. They had worked so hard and suddenly it all felt like sand running through his fingers.

Fortunately, we had introduced the partners to an excellent tax partner at the local office of a major national accounting firm. We told both owners that a solution could likely be designed that could potentially save the business and satisfy the beneficiaries of the estate. But there would have to be some flexibility on both sides and serious attention given to inter-generational planning. They were all ears.

On the advice of their tax advisor a new partnership agreement has been written, an estate freeze was completed for each of the two remaining brothers, holding companies and discretionary Trusts were set up. The next generation, who are working in the business, now have an equity interest in the business.

The widow received the shares through the spousal rollover. The company purchased life insurance on the widow to fund a repurchase of her shares upon her death.

We placed the correct amount of life insurance on the two owners.

Now the liquidity need for a complete share repurchase is in place.

Regular review of the share values will take place.

Using our proprietary software and custom life insurance funding strategy we have shown that insuring the next generation will have a nominal interference with cash flow and could produce substantial tax benefits now and in the future.

For years proposals by life insurance advisors to the shareholders had been seen as trying to sell something. Not so! Directing funds away from the business into a life insurance policy seemed like a poor use of cash flow. Understandably, the thinking was “that money could be used to buy another income producing asset, its too expensive.”

Never confuse the price of life insurance with the cost

Understandably writing a cheque to a life insurance company is only marginally more attractive than writing a cheque to the tax man. But properly acquired and structured corporate owned life insurance can be a sound investment that produces much needed liquidity no matter when it is needed; at the unexpected death of a shareholder.

Business continuity planning is an important part of running a business. Whether planning for an unexpected death or disability of a partner, retirement from the business or estate planning, it is important to have regular in-depth reviews of any plans in place.

Funding the liquidity to achieve those objectives in a tax and cash flow efficient manner should underpin partnership agreements. This is where our expertise and decades of experience working with tax advisors and senior levels of major Canadian life insurers has helped successful business owners and their families across Canada.

It is better to plan than panic.