Presented by: Business Continuity Planning Tom Pilkington CA CFP TEP National Estate and Tax Planning Consultant Ontario Regional Marketing Centre Keyperson Protection Funding Shareholder Agreements Global Financial 2007 Kick-Off Meeting Wednesday, January 10, 2007

2 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

3 Agenda  Business continuity planning  Keyperson protection  Funding shareholder agreements

4 Keyperson Protection

5 The success of a business  The right strategy  The right product / service  The right market  The right price  The right people!

6 Who are the key employees  Key decision makers  Financial and operations management  Research  Technology  Marketing  Sales  Etc.

7 Who are the key employees  The owner-managers  Any other employees who have a financial impact on the success of the business

8 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!

9 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?

10 The solution  Business earnings?  The bank?  Family?  Friends?  Investors?  Life insurance!

11 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

12 Prospect profile  Private corporation (small or large)  Closely held  Owner-manager or other key employees  Age , healthy  Cash flow to pay premiums

13 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?

14 Funding Shareholders Agreements

15 The problem  What happens to the shares of a deceased shareholder if there is no prior arrangement OPCO Mr. A Mr. C Ms. B

16 The problem  Shares pass through the deceased’s estate to the surviving spouse / kids / other beneficiaries, who then become owners in the business

17 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

18 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

19 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

20 Events covered in an agreement  Dissension between the parties  Third party offers  Marital breakdown  Insolvency  Retirement  Disability and/or critical illness  Death

21 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

22 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

23 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

24 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

25 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

26 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

27 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

28 Case study SmithJones OPCO 50 Shares 50 Shares Fair Market Value = $1,000,000 FMV = $500,000 ACB = $0 PUC = $0 FMV = $500,000 ACB = $0 PUC = $0

29 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!

30 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

31 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!

32 Questions? Thank You!