By John A. Wenstrup
You know how vital each person's contribution in your business is. Imagine what would happen in the case of a disabling injury or prolonged illness. The disability of an owner/partner complicates matters even more than death or retirement.
If you were the remaining owner?
If a key person's disability were to persist for a year or even more, you might begin to ask yourself these questions: How long can we afford to operate without our associate's help? When should we begin to think about hiring a replacement? How can we afford to keep paying our partner? What happens now to the business loans the bank made us both sign for personally?
If you were the disabled owner?
You've invested in the business, helped it grow and been a major decision maker. Now you're disabled, and you might start thinking: How can I hope to recover my capital investment? Why should I have to let someone else run my business, using my money? Where is the return on my money that I should be receiving, considering I helped found the business? What will happen to my family and me? Is there a possibility that I will lose my house?
The Buyout Agreement
In order to finance a buy-out of the disabled partner's share of the business, the company must come up with a great deal of capital. And just where does that money come from? Most firms would find it very difficult to come up with enough cash to pay for the partner's share or to set up a reserve in advance.
Disability buy-out insurance is designed specifically to provide the company's owners with the money they would need to reimburse a disabled owner for their financial interest. The first portion of the disability buy-out agreement, the salary continuation agreement, usually assumes that personal disability insurance for owners is already in place. Benefits begin after a specified waiting period, during which time the firm continues to pay the associate's salary through a salary continuation agreement. After the waiting period, the firm is able to reduce salary payments because of the benefit received through the disability insurance.
The second portion deals with prolonged disability, extending beyond a year, and most disability buy-out agreements take one of three approaches:
Do-Nothing
Since the odds indicate that a long-term disability often terminates in death, some companies choose to play a waiting game, which would ultimately be resolved by a life insurance buy-out. However, if the owner remains disabled for years, the costs of continuing their salary can be devastating.
Readjust Ownership
Perhaps the disabled owner's interest could be readjusted, usually by making him or her a limited partner or by issuing preferred, non-voting stock.
Pre-arrange Purchase
This alternative calls for the firm or the other owners to purchase the entire interest of the disabled associate for a price agreed upon in advance. Ownership is then transferred at once, with the money paid either in a lump sum or in installments, or a combination of the two.
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The Wealth Alliance does not provide tax or legal advice. Tax laws are subject to change.
513-248-9242
John A. Wenstrup is a Chartered Financial Consultant and president of The Wenstrup Company. John specializes in retirement, wealth transfer & business succession planning.
The assumptions are subject to change and actual results will vary. |
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