Exit and Business Succession Planning: The Disability Problem

Death of an owner is actually a little easier to plan for than the disability of an owner. Both situations raise very similar questions, for example, (1) who will do the work the owner was doing?, (2) how will the owner, or the owner’s family, survive?, and (3) who will step in to make decisions about running the business.  However, there are a few practical, big differences. 

When an Owner Dies…

When an owner dies, if the business has made basic plans, the situation can trigger a relatively clear succession process that can often be funded by life insurance.  Usually, the owners have determined who will buy the ownership interest, keeping the control of the business in predetermined hands.  Using life insurance, the business can use the funds to buy the deceased owner’s interest, and the family or heirs of the deceased owner have funds to take care of themselves.  In addition, the owners will hopefully have a good understanding of the work done by the owner, and can find a replacement using the same funds paid to the owner before they died.  And because the deceased owner is no longer in the picture, the remaining owners have, or the new owner has, the freedom to take the business in the direction they prefer going forward.

When an Owner is Disabled…

In contrast, when an owner is disabled, issues are muddled for several reasons. The disabled owner has not died so life insurance is not triggered and funding for both a replacement worker and for the ownership interest can be more problematic, not to mention how the disabled owner is going to be taken care of themselves when they can no longer work. When an owner dies, they are out of the picture, but a disabled owner could get better and may want to come back to their business later.

Two Approaches for Disability

Business owners basically have two general choices when disability is addressed.  First, they could decide to treat a disability like a death, but this poses a couple of challenged.  It means the owner who is disabled gets removed from the business even if they recover. If they get better, they may have to buy back into ownership, and could be kept out.  In addition, it may be hard for the business to find a source of cash in a short time period, to pay for the disabled owner’s interest without life insurance.

A second general approach is to put in place a kind of time delayed buy out. The owners could decide to put mechanisms in place that provide for the owner to be taken care of when they cannot work, like disability insurance and disability overhead insurance.  The business can then use the funds previously used to pay the owner for their work, or insurance proceeds, to pay for a temporary replacement. In addition, the owner can work with the other owners, or with trusted advisors, to give someone authority, through a power of attorney, to act on their behalf, and for their interests, during a disability.  In short, the business comes up with a workable plan to address short term disability so the business, and the disabled owner, can survive.

Regardless, if a disability continues in the long term, the owners will need to have a time when they will go ahead and proceed with buying out the disabled owner.  Because the buy-out takes place later, and the business and owners have in place temporary measures, the business will generally be in a better position to put together a package which will keep the business viable for the long term. For example, the business will have time to put money together to buy out the disable owner. The business might also be able to find an individual who is willing to buy into the business, and essentially buy the disabled owner’s interest.

Conclusion

The disability of the owner will present more difficulties, but those difficulties  can be mitigated by good planning and flexible documentation that is designed to help the business and owners. The bottom line is that there has to be planning both for a death situation, and for a disability situation.  The two are not the same, and must be addressed according to the unique challenges and circumstances the different situations present.

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