A buy-sell agreement is an integral part of a business’s comprehensive succession plan. When triggered by an unexpected event, such as the death of an owner, a properly executed agreement can provide a smooth transition of ownership and unimpeded operation. In addition, the buy-sell agreement can give the deceased owner’s estate the funds necessary to meet tax obligations or provide a legacy for family members.
Funding a buy-sell agreement for the death of an owner with life insurance is generally recognized as a good business practice. Unfortunately, many business owners who are concerned about the sale of their business interests at death may be less concerned about selling the business in the event of total disability.
Minding the Store
This mindset — “It won’t happen to me” or “I’ll still be able to run the business if disabled” — can prove harmful to the business in a number of ways. First, the chance of an owner becoming disabled during their working years is more common than you might think1. Second, the negative effects of a death on the disposition of business interests can be the same for a total disability. And third, but certainly not last, is the determination by the business owners of whether a disability has even occurred. In the event of an owner’s total disability, these scenarios can cause future disputes among stockholders and families, ultimately leading to disruption of the business.
To add another perspective: The disabled owner is still living, struggling with either a physical or mental incapacitation. And their loved ones may be required to provide costly, ongoing care. In this situation, emotions may run high, causing unwanted distractions for everyone involved; owners, their families and the employees.
When drafting your buy-sell agreement, it is advisable to include provisions for a disability buy-out. Several factors to consider are the definition of disability and the length of time an owner must be disabled before the buy-out is triggered. Also consider how the value of the business will be determined and if the buy-out will be paid as a lump sum or as installments over time.
The same rationale for using life insurance to fund a buy-sell obligation upon the death of an owner applies to using a disability buy-sell policy here. In addition to the policy being the provision’s funding mechanism, your disability buy-out insurance policy can provide a critical component of the agreement itself: the definition of disability. By having the agreement’s definition of disability incorporate the definition contained in the insurance policy that will fund the buy-out, the burden of determining whether the definition has been met, and the buy-out agreement triggered, is no longer shouldered by the stockholders. The determination whether the owner’s disability meets the policy’s definition is made by the insurance carrier.
Of course, the definition of "disability" will vary from carrier to carrier, and from policy to policy. It is important, however, that you seek guidance from your legal and Financial Professionals as you review policies and carriers to help ensure you select the best policy available to meet your company’s needs.
Is It Really Missing?
If you have an existing buy-sell agreement, it makes sense to review it regularly to ensure it continues to meet the business’s needs. Change is constant in a business and you need to see to it that your agreement stays current. Another benefit of reviewing your existing agreement now is that you might find that it already has a disability provision included. However, many buy-sell agreements that already reference a disability may not clearly articulate the definition of disability, or take ownership disposition and funding into consideration.
Some might call that an "unfunded liability," while others would say it’s a "ticking time-bomb." Either way, it is important to take the time to see what is, and isn’t, missing from your buy-sell agreement.