By: Christine Cox-West, LUTCF
In our collective 35+ years in the business, our partners have never experienced so many buy sell planning cases. Is there some sudden, massive need for planning? I tend to think not. However, the recent pandemic has people thinking. For most individuals and business owners, they are now experiencing what it would be like to go without income and revenue for one month, two months and maybe even three months. Imagine if a disability struck. Imagine going one year, two years, three years (the average disability claim[1]) or indefinitely without income. I believe what has made business owners more aware is the fear that coronavirus could impact them if their partner became ill and suddenly passed. But that risk has always been present. As advisors, we know that there are thousands of ways that a person could die. Successful business owners driving on the road every day could get into a fatal car accident. A stroke or heart attack from a stressful job or an unhealthy lifestyle could permanently disable or kill a partner. Uncertainty has never been instilled in business owners like it has been in these past few months, however.
I was on a client call with two successful business owners last month along with their commercial broker. They discussed their fear given the current environment and their desire to execute a buy sell agreement. Like many, this had been something they were planning on doing but never got around to. But the uncertainty of the novel coronavirus made them act. On the call we discussed the basics of a properly structured Buy sell agreement. In the event that either partner passed away, the other partner would purchase their ownership in the business from the deceased partner‘s estate. As neither of the owners’ spouses were in the business, it would be very difficult for the deceased spouse to assume responsibilities in the same manner as the deceased partner. It would also not be fair to the surviving partner for the deceased’s spouse to continue receiving revenue from a business they could not be materially involved in. For similar reasons, if one of the partners became disabled, the buy sell would also trigger. The non-disabled partner would be required to purchase the ownership of the disabled partner after a specified duration of disability. As a surviving spouse would not be able to properly participate in the business following the death of their spouse, a disabled partner also cannot live up to the responsibilities of running the business while disabled. The question is Where do the purchasing partners come up with the necessary assets to buy their exiting partner’s equity? The most efficient way to do this is by purchasing life and disability insurance. By transferring the risk to an insurance carrier, the business owners can fund their buyout for pennies on the dollar. When we explained these concepts, the clients were familiar with the need for life insurance. They had done a little research in advance and had come prepared. However, when it came to the concept of funding the buy sell with disability buy out insurance, they did not see the value. They believed that in most cases they would be able to keep working if they were disabled. At least that is what one of the partners had said. The client also did not fully understand that within their agreement, the non-disabled partner could not have the disabled partner just “work through it”. If the disabled partner wanted out, the remaining partner would be forced to buy and would have to come up with the money one way or another. As advocates for our clients, and in helping them make decisions that are in their best interest, we further discussed the reasoning for purchasing disability buy out insurance. The average amount of term life insurance cases that pay out is about 1%. More than likely (and hopefully) these partners will never have to use the life insurance policies to fund the buy out. As we know however, if they do need it, it could potentially save them from financial devastation. When it comes to disability insurance, the statistics are very different. One in four 20-year-olds will become disabled for at least one year before age 651. A disability of a business partner is far more likely to occur than the death of a partner. However, it is a greatly under sold product and most businesses do not fund their buy sell agreements with disability insurance. This gives advisors significant opportunities to advocate for clients and be the advisor that does not overlook such an important piece of the agreement.
The broker I was working with on this case shared his own story of his family’s agency. His father had bought into the agency in 1996 with two other partners. Years later, one of the partners suffered a ruptured aorta, needing emergency surgery. He was in the fortunate 1% of patients who survive such a procedure but was out of work for months. Although he came back for a short period of time, he was never close to 100% and retired. The broker’s father and his partners had, years earlier, discussed the importance of funding their own buy sell agreement with life and disability insurance but never funded the agreement. Not too long after the first partner suffering the ruptured aorta, his father’s other partner began having gastrointestinal issues and lost 40 pounds, being misdiagnosed for over a year. Ultimately, he was diagnosed with Celiac. Again, this partner tried working from home before being put on a long-term disability claim and ultimately retiring at an early age. Having a fully funded and executed buy sell agreement would have funded both buyouts. Instead, separate corporate loans from a bank were taken out. Although this may be a solution for some businesses, borrowing is certainly a more costly option. Additionally, there are no guarantees that the business will be able to borrow at favorable rates, or for the amount they need. Financial stress at a difficult time for the business is likely. In this business’ story, they had two out of three partners face disability. These were not from freak accidents. These were from illnesses prevalent in our country, that millions face.
After sharing this story with the clients, the more senior client on the phone said, “To be honest, if I became disabled that would be my reason to retire.” After hearing this response, the younger partner who was originally against paying for the disability insurance, without hesitation said, “We definitely need this”. It is so important for business owners to have open communication with each other. What would be the plan in the event that one of them became disabled or passed away? Most successful businesses with partners need a buy sell agreement. By working with expert attorneys and advisors in these areas, business owners can insulate themselves from unexpected losses of partners. Just as important is properly funding these agreements so business owners are not left with having to find such a significant amount of money, for possibly the largest purchase of their life, at possibly the very worst time in the history of their business.
[1] Awareness, C., 2020. The Average Duration Of Long-Term Disability Is 31.2 Months. Are You Prepared? – Council For Disability Awareness Blog. [online] Council for Disability Awareness Blog. Available at: <https://blog.disabilitycanhappen.org/the-average-duration-of-long-term-disability-is-31-2-months/#:~:text=Industry%20studies%20show%20that%20the%20average%20long-term%20disability,than%2075%25%20of%20Americans%20live%20paycheck%20to%20paycheck.%29> [Accessed 26 June 2020].
