December 21, 2014

Avoid the horror show, get a buy-sell arrangement done (part two)

In part one of this two part post, I wrote about buy-sell arrangements and how that will protect business partners against the unexpected death of one of their own. Circumstances that come with the death of a partner can vary, but in the end, surviving owners need to be concerned with people and entities that will have competing interests if such folks wind up with the the decedents ownership stake in the company.

In this part of the blog we will tackle what happens if a partner in a company becomes disabled. In an instance such as this, the dynamics change. In the event of a partners passing, co-owners would need to deal with outside parties. In the event of a disability, you’re not dealing with outside parties, you’re dealing with your cofounder or partner. This is going to change the way things are treated.

A disability to a co-owner can create some uncomfortable problems if the event is severe enough. What if such an event is bad enough that a co-owner can no longer work at all? Maybe worse than that, what if you have to break the news that while a partner may feel he or she is good to go, they just can pull the weight anymore?

To start, we will discuss the worst case scenario, a permanent disability that simply will not allow one to work in the business anymore. Over the course of one’s working career, the chances of suffering a disability versus the chances of dying are about 3.5 to 1. In your younger days, that ratio is higher and as you age that ratio decreases. Given the chances of such an occurrence, the need for disability as part of a buy/sell arrangement becomes pretty clear.

So what happens? In the event of total disability, the disability buy/sell arrangement will dictate a process, a valuation model and if done properly, a funding method using disability insurance to fund the buyout. Within a complete corporate buy/sell arrangement, there will be a component in the event that a disability that will not allow for a partner to continue in such a capacity. Should this occur, it would trigger the terms of a buyout per the terms of the arrangement. For funding purposes, disability buy/sell insurance coverage should be put in place in order to finance the arrangement. Without the insurance proceeds, one partner would have to either have cash on hand, or raise the funds independently to finance the buyout.

Short of that, what you have is one partner running a business with a second partner simply along for the ride. Not the scenario the partner running the show at that point would feel to be fair to him or her.

What if there is no total disability? What if it isn’t permanent and all parties feel that the owner will fully recover and be able to return to work? This is where Disability Key-Man coverage comes into play. This becomes the middle ground that will cover a company for the expenses incurred while a key person is out on disability. It should be tailored to sufficiently stabilize the company while determinations can be made regarding an employee return or ultimately replacing said key person. This issue is more complex than the brief description given here and will be explored more completely in a different blog post.

The disability recovery scenario is why most buyout triggers of a buy/sell agreement dictate that a partner be deemed totally disabled and that a long probationary, typically 12 months, be subject to the triggering of a buyout. A business owner will not be too quick to hand over a stake in a business if he or she were to believe that they will be able to recover from an incident. Quite frankly, a business owner may plain and simple never give up the stake regardless…unless there is a preset arrangement with parameters in place.

As a disabled owner, without a formal agreement there is nothing forcing the issue to trigger a buyout. A disabled owner could set their own price that a co-owner doesn’t agree with or is simply an unfair valuation. A disabled owner could go out in the open market and find another buyer to take over their stake if he were to find someone other than a co-owner to meet his price. Where does that leave the healthy partner? Without the arrangement set in stone, one could be looking at running the company essentially by himself, a new business partner, and if things come to a head, the disillusion of the company entirely.

It doesn’t need to happen and both parties owe it to themselves to get ahead of such things. When an instance such as a disability occurs and the potential impact of business becomes an issue, egos and feelings get involved, that helps no one. Take it out of the equation now.

For more information on the topic or guidance, use the form below or reach out directly to Nathan Therrien at 978-400-7014 or at [email protected]

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