Sole Proprietor Insured Disability Buy-Sell Plans Pt. 1

The disability of a business owner has no legal impact on the ability of a closely-held business to continue to operate.  However, the practical consequences can have a very serious impact on not only the owner but the owner’s family and the employees of the business.  An insured disability buy-sell plan can alleviate the stress of funding.

The business can suffer a serious blow if the expertise of the disabled owner is lost. Another consideration is the continuation of an income to the disabled owner and the impact it will have on the business.  Finally, the question of if the firm’s employees will be able to manage and operate the business without the disabled owner’s expertise.

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Problems Faced by a Disabled Business Owner

Two major problems faced by a business owner who becomes disabled are the family income and the value of the business.

When a business owner is disabled, a question that must be addressed is one of ongoing income for the family.  If the business is able to continue an adequate income to the disabled owner, there are several questions that will eventually be asked:

  • How long will the business be able to maintain the income to the disabled business owner?
  • When the income ends, what other sources of income are available to the disabled owner?

The profitability of the business will dictate the overall value of the business which can change if an owner becomes disabled.  If the business is affected by the absence of the disabled business owner, some questions that may be asked include:

  • What impact is the disabled owner’s absence having on the profitability of the business?
  • How will continuing an income to the disabled business owner impact the overall value of the business?
  • How can a disabled owner receive the fair market value of his or her share of the business?

The Odds of Becoming Disabled

The odds of a business owner becoming disabled for 90 days or longer before they reach age 65 vary with age and the number of business owners.  Also, depending on the age of the business owner when the disability occurs, the average duration of the disability varies from 2.2 years to 2.9 years.

For example, a business with a sole proprietor age 30 stands a 54% chance of the business owner becoming disabled before age 65.  That percentage jumps to 98% when there are 5 business owners.  Interestingly, that percentage goes down when comparing a 30-year-old at 54% with a 55-year-old at 25%.  However, no matter the age of the business owners, one fact remains true:  the more business owners, the higher the likelihood that at least one of those individuals will become a disabled business owner.  This is why a disability buy-out insurance policy is important to any business owner.

Disability Buy-Out Insurance

If a key employee, relative, or even a competitor is a potential purchaser for the business, an insured disability buy-sell plan can allow for an orderly transfer of business ownership at the disability of a business owner.  When a business owner implements a disability buy-sell plan before becoming disabled, insurance can be used to provide the funds needed to purchase the owner’s interest for a previously agreed-upon price, if the owner becomes disabled.

The following can be accomplished with advanced planning and purchase of an insured disability buy-sell plan:

  • The guaranteed sale and price of a disabled owner’s business interest are procured.
  • The funds necessary to complete the sale of the business are available at the owner’s disability, exactly when needed.
  • Benefits to the business owner from a source of cash that can be used for ongoing income.
  • Avoidance of forced liquidation of the business due to a disability.
  • The minimization of loss of business momentum.
  • Funds are more readily available to hire a replacement.

Funding a Disability Buy-Sell Plan

There are four different ways to fund a disability buy-sell plan:  cash, installment, loan, and insured method.

Cash method involves accumulating enough cash to sufficiently buy the business interest upon the owner’s disability.  However, it may take years to save the necessary funds.  If these funds are needed in just a few months or years, there may be significant problems for the business owner who now has to desperately scrounge for enough cash to meet the needs to the business.  Additionally, accumulated earnings tax problems may arise for corporations.

After an owner’s disability, the purchase price could be paid in installments over time.  This could mean a significant drain on the new owner’s business income for an extended period of time.  Future payments would also be dependent on the performance of the business after the owner’s disability.

A business or personal loan may be incurred.  If the new owner can obtain a business loan after the previous owner’s disability, the disabled owner would receive full funds, but the business may suffer from a large loan amount.  If the new owner is a spouse or other family member, this may ultimately affect the overall quality of life for the entire family.

Finally, the easiest and least stressful method of preparing for a business owner’s disability is with disability buy-sell insurance.  Only disability buy-out insurance guarantees that there is sufficient cash to complete the sale.  The funds can be set up to be received as a single lump sum or in installments.  This is only assuming that the business has been accurately valued.  Guarantees are subject to the claims-paying ability of the issuing insurance company, so choosing one with a solid reputation is key.

The other positive aspects of a buy-sell disability insurance policy are that there is always a buyer for the business, the income paid to the disabled owner will not impact the business’ income or profits, and the assurance that the disabled owner will receive a fair price for the business.  Even if an owner does not make payments equal to the amount of the buy-sell disability insurance policy, the full amount is paid immediately upon the owner’s disability.

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