Lecture Notes: Disability Buy-Sell Agreement for Business Owners

Introduction

• Focus on the risks faced by business owners with an emphasis on disability.
• Discussion on Disability Buy-Sell Agreements and disability income policies for funding a buyout.

Key Concerns for Business Owners

• Disability, death, or critical illness of a business owner can raise significant concerns.
• Impact on family:
  • Can the family operate the business?
  • Does the family possess the necessary skills?
  • Desire to continue the business.
• The business as a significant family asset; potential need to convert this equity to liquid cash.

Business Continuity Concerns

• Employees might be worried about their job security.
• Retaining key employees is crucial for business continuity.
• Co-owners may not support a non-productive, disabled owner over the long term.
• Potential involvement of the disabled owner's family in the business can be problematic.

Importance of Planning

• Issues should be discussed and planned in advance.
• Many business owners fail to address these issues timely, causing problems.

Formal Binding Agreements

• Business owners can enter into binding agreements specifying actions if an owner becomes disabled or dies.
• Agreement includes:
  • Who buys the owner's portion
  • Purchase price and valuation method
  • Source of funding for purchase
• Obligations for all parties involved:
  • Obligation to sell if disabled
  • Obligation to buy for survivors in case of death

Insurance to Fund Agreements

• Life insurance for death scenarios; disability policy for disability scenarios.
• Crisscross ownership: co-owners own policies on each other's lives.
• Share Redemption: business owns policies, funds used for redeeming shares.

Features of Disability Buyout Insurance

• Regular occupation definition of disability.
• Own occupation definition available for professional practices.
• Policies are renewable and non-cancellable.
• Longer waiting periods (12-24 months) than regular disability plans.
• Benefits are provided in lump-sum payments after the waiting period.

Lump-Sum Payments

• One lump-sum payment post waiting period, instead of monthly benefits.
• Provides a year for potential rehabilitation of the disabled owner.
• Lump-sum used for fulfilling purchase obligations under the buy-sell agreement.

Coverage and Risks

• Maximum coverage typically ranges from $1 million to $2 million.

Conclusion

• Reference to Table 5.1 for a summary of business risks and insurance policies.

Summary

• A disability buy-sell agreement helps ensure the continuity of a business in the event of an owner's disability.
• It is crucial for business owners to pre-emptively address these risks and have formal agreements and insurance in place.