Many individuals purchase insurance to protect the family against financial hardship. Life Insurance is purchased to protect the family income if one of the spouses were to die earlier than expected. Disability insurance provides a solid form of income replacement if one of the spouses is unable to work due to injury or sickness. Finally, Critical Illness insurance provides instant liquidity in the event of an acute health event. All are vital for an overall sound financial security plan.
What about the business? Often, business partners will have a Buy Sell Agreement. This agreement sets out what will happen with the shares of the business if a partner dies earlier than expected. Typically, the agreement stipulates that the surviving partner buy out the shares from the survivor of the deceased partner so that the remaining partner can take control of the business and continue onwards as a going concern. Funding the buy sell agreement is easily accomplished on a most cost effective basis using Life Insurance. If the Partner dies, the policy pays out the death benefit into the corporation.
The life insurance proceeds are used to purchase the shares from the survivor of the deceased partner. A buy sell agreement typically always addresses the issue with respect to the death of a partner. However in many of my reviews, that’s where it ends. I then ask the question, “What happens if one of you has a disability?” This is a huge risk that can cause a significant drain on the business and ultimate failure unless it is handled properly.
A good example would be two partners in a business. Both have worked hard to build up the business value that is quite significant. What happens if one of the partners becomes disabled? If there is no wording in the Buy Sell agreement, the business would be obligated to continue income payments to the disabled partner indefinitely. How long would the healthy partner be able to “hold down the fort”? Perhaps the partners would be forced to sell the business at a distressed (discount) price. The disabled owner would want to be bought out but would be at a disadvantage in negotiations and not realize the value of what they actually contributed to the business.
How would the bank feel about a partnership that is weakened due to the disability of a partner? Perhaps a loan would be called which would put more stress on the business. These are the risks and these are the realities!
A well drafted Buy Sell agreement should be very specific in terms of its wording on what should happen if a partner becomes disabled. It should spell out how long the business would continue with a disabled partner and then identify a trigger date. Disability Insurance would be used to fund this portion of the agreement. The policy would be implemented for each partner whereby a benefit is paid out to purchase the shares of the disabled partner once the “trigger date” is set.
Incorporating a disability clause into the Buy Sell agreement is halfway to solving the problem of a partner becoming disabled. Funding it with the right product and structure to meet the agreement terms is the completion of this very important plan.
When was your Buy Sell agreement last reviewed? Does it address what were to happen if one of the partners has a disability? Is there funding in place by way of disability buy out insurance to address the need?
We can review your agreement and make recommendations if necessary to ensure that your actions are in alignment with your business interests and intentions in the worst case scenarios!
