What does a buy and sell agreement have to say about the coverage?

How it works

both failures come from one decision

How this goes wrong, named in advance

1. 01Early surrender, when the costs fall heaviest
2. 02Lapse while an advance is still outstanding
3. 03A taxable gain arriving with no cash to pay it
4. 04Funding a contract the household cannot sustain
5. 05Drawing on the contract without ever repaying

The agreement creates the obligation and the coverage funds it. That order matters, because money arriving with no obligation attached is simply money in somebody's hands, and the people who expected it to buy shares have no document compelling anyone to sell.

Putting the pieces together follows a sequence too. The shareholders, usually with a lawyer, negotiate and sign the agreement itself, which states the trigger events, the valuation method and the funding mechanism in words. Separately, and sometimes years apart, each shareholder or the company applies for the coverage that is meant to fund the obligation the agreement describes. An insurance representative places that coverage, an insurer underwrites and issues it, and the company or the shareholders pay the ongoing premium, depending on how the agreement itself assigns that cost. Nobody at the insurer reads the buy and sell agreement before issuing the contract, and nobody drafting the agreement is obliged to confirm the coverage actually matches what was written, so the two documents can drift apart from the very beginning and not only over time.

How the shares are valued differs by agreement, by industry and by the accountant retained to do it, and a formula that produced a reasonable figure when the company was small can produce a distorted one once it has grown, been through a difficult year, or added a line of business the formula never anticipated. The question of whether the funding mechanism is a promissory note, a share redemption, or a criss cross arrangement between the shareholders directly changes who is taxed on what, and the choice made when the agreement was signed does not automatically stay the right choice as the shareholders' own circumstances change with age, health or ownership percentage.

Nobody is assigned by default to notice when the two documents drift apart, since the insurer administers the contract and the lawyer administers the agreement, and neither one is retained to compare the two against each other on an ongoing basis. Reviewing the coverage on a set schedule catches this only if the review specifically checks the coverage against the agreement's own valuation, and not only checking whether the premium is still being paid, and a review conducted by the same representative who placed the original coverage carries the same question about incentives raised elsewhere on this site about who benefits from what gets recommended next, a question worth asking plainly and not assuming an answer either way.

The cost or the catch

five steps, and you may stop at any of them

From first conversation to a contract in force

1. A thirty minute discovery meeting, with no products
2. The suitability record a licence requires before advice
3. A design meeting, guarantees shown separately
4. Application and underwriting, decided by the insurer
5. An annual review once the contract is in force

To be accurate about it. Agreements go stale quietly. Shareholders change, values change and the coverage stays the size it was, so the commonest failure is not an absent agreement but a current one describing a company that no longer exists.

The bad news is specific. A shareholder who dies while the agreement and the coverage have drifted apart leaves the survivors holding a document that promises a transaction the money on hand cannot actually complete, at exactly the moment when negotiating a different arrangement is hardest, with an estate on one side and a suddenly smaller ownership group on the other. Underinsurance relative to a current valuation is the more common failure, but overinsurance is its own quieter problem: money arrives that the agreement does not clearly say what to do with, which can itself become a shareholder benefit if it is not directed according to the agreement's own terms.

Unwinding a mismatch discovered while everyone is still alive is a paperwork exercise: amend the agreement, adjust the coverage, and move on. Discovering it only after a death has occurred removes that option entirely, since the agreement cannot be renegotiated with a shareholder who is no longer there to sign anything, and the survivors are left applying an outdated formula to a transaction that can no longer be postponed, negotiated in the worst possible week to be negotiating anything at all.

What to ask, and of whom

Ask the lawyer who drafted or last reviewed the agreement when it was last actually read against the current shareholder list and the current valuation, rather than assuming a document signed years ago still describes today's company. Ask the insurance representative to confirm, in writing, whether the coverage currently in force actually matches the amount the agreement's own valuation formula would produce today, since those two figures are answered by two different professionals working from two different documents.

For the valuation itself, ask the company's accountant to run the agreement's formula against this year's numbers, not last year's, and ask what would change if the formula were applied to a materially different year, such as one with unusually high or low earnings. For how the funding mechanism chosen would actually be taxed to each party involved, that question belongs to the CPA as well, since the promissory note, the share redemption and the criss cross arrangement each carry a different tax result that the agreement's own wording does not, by itself, settle. Ask, too, whether the agreement's coverage addresses only death, or whether it is also meant to fund a buyout triggered by disability or voluntary departure, since coverage bought only for the death scenario provides nothing at all when one of those other triggers is the one that actually occurs.

Who this affects most, and who it barely touches

if one is missing the answer is no

Four things required before anything else

1. 01Durable surplus cash flow, in an ordinary year
2. 02A horizon measured in decades rather than years
3. 03A place in the household's wider position
4. 04A clear purpose for the contract itself

This matters most to companies with more than one shareholder of meaningfully different ages, health, or ownership share, since it is exactly that mix of differences that makes a stale valuation or a mismatched funding amount likely to advantage one side of a transaction the agreement was meant to make fair to both. It matters far less to a single owner corporation with no other shareholder to buy out, or to a company whose shareholders have already agreed, in writing and recently, to wind down together and not transfer ownership between themselves.

It also matters more to a company that has grown quickly, taken on debt, or changed its ownership structure since the agreement was last reviewed, since each of those changes the number the valuation formula would produce today without changing a single word of the document itself, which is exactly why a document can look unchanged while the situation it describes has moved considerably.

What this page will not tell you

This page does not say what your own agreement's valuation formula should be, how much coverage your own company needs, or which funding mechanism suits your own shareholder group, since each of those depends on facts specific to your company that only your own lawyer, accountant and insurance representative, working from your actual documents, can determine. The insurance representative involved is ordinarily compensated by commission on the coverage placed, which funds the mechanism but does not itself answer whether the mechanism chosen is the right one for your company. It also does not remind you, on its own, to check any of this again next year; that reminder, like the review itself, is something the company has to build into its own calendar. Slow decisions age better than fast ones.