Partnerships account for 8 percent, or 2.2 million, of all business forms, according to The Tax Foundation. When two or more individuals own a business additional planning is required to prevent a financial fallout, should one owner become disabled. Disability buy-out insurance is a type of specialized insurance coverage designed to protect businesses with multiple owners.
Disability buy-out insurance is an important component of any business succession plan or business continuation plan. A DBO policy protects all business owners from the risks posed by the serious disability of one owner. This policy provides the opportunity to the remaining business owners to buy out the disabled owner’s shares at an agreed-upon price outlined in the buy-sell agreement.
What Is Disability Buy-Out Insurance?
Disability buy-out (DBO) insurance is used to fund a buy-sell agreement to buy out a business owner who becomes disabled and is unable to perform job duties. DBO coverage maximizes the financial return when the business is transferred. Businesses covered under DBO insurance also face lower tax liability.
A disability buy-out policy generally requires a claimant to be totally disabled for a minimum of 12 months. The buy-out must also take place in accordance with the previously established agreement that was signed by all parties. With funding from DBO insurance, the remaining owner(s) are able to continue operations.
Before a disability buy-out policy can be acquired, a buy-sell agreement must be created that includes the fair market value of the business. With this information, a sales price can be negotiated and a policy can be purchased on the life of each business owner.
Following an illness or accident that results in a complete disability, there is a standard “waiting period” that must be satisfied before the insurance company will pay out benefits. The elimination period begins at the date of the initial disability and can extend to 12, 18, or even 24 months. The longer the elimination period, the lower the cost of coverage.
Once the elimination period has been met, benefits are paid out to the remaining business owners. Continual disability does not need to be confirmed. Benefits may be paid out as a lump-sum or as scheduled payments over the course of 2, 3, or 5 years, depending on the terms of the agreement.
Who Should Acquire a Policy?
When a business owner in a partnership becomes totally disabled, the remaining owners may have difficulty sustaining operations. Disability buy-out insurance allows remaining owners to continue the business without having to obtain a loan, use business revenue, or sell shares of the business in exchange for capital.
Not all businesses require disability buy-out insurance. This type of insurance policy is most often targeted to small, established businesses and businesses with succession plans. The amount of coverage that a business will need will range based on the value of the business, the number of owners, the industry, and similar considerations.
Businesses that should consider acquiring DBO insurance include:
Disability buy-out insurance is best suited for small businesses with fewer than 10 owners. Businesses who have been in existence for three years or more, or more than one year for service businesses, should also acquire a policy. In addition, DBO insurance is ideal for businesses valued under $10 million.
If one owner should suffer a complete disability, the remaining owners may have difficulty covering common expenses. Funds from a DBO insurance payout can help small businesses cover a wide range of common business expenses, such as payroll, lease payments, insurance, and utilities.
Business Owners with Key Partners
The absence of a key partner due to a disability can leave financial gaps within an organization. A key-person who is critical to business operations can result in work left undone and if the remaining business owners cannot find a replacement fast enough, the business may never recover.
When contemplating whether or not a business needs disability buy-out insurance, consider the impact that a disability would have on the company’s income and operations. Also, consider the responsibilities of the key partner and how difficult it would be to find a qualified replacement.
Businesses with Succession Plans
Business succession planning is an effective way to secure the life of a business long-term. It can also be used as a guide on how operations should be carried out if a business owner should leave their position, voluntarily or not. Serious disabilities are often unexpected; therefore, it is important for businesses to prepare for health-related events accordingly.
Disability buy-out insurance is recommended for any business with a succession plan. Succession plans generally include buy-sell agreements that act as a road map on how a company should continue operations in the event of an owner’s untimely disability or death. A succession plan may also include key-person disability and life insurance which can help offset financial losses, such as lost revenue and the cost to recruit and train a replacement.
What Happens If I Don’t Have a Policy?
Some businesses may hesitate when making the choice to acquire disability buy-out insurance due to the additional expense. Other businesses may wonder if they really need a DBO policy or if they can get by without one. The truth is that there is always a chance that a severe disability could occur without notice.
Without disability buy-out insurance, the remaining business owners would be forced to either continue operations without aid from the disabled owner or make the difficult decision to close. Most small businesses do not have the funds required to buy out an owner without resorting to a loan or alternative means of funding.
Speak to the Experienced Succession Planning Consultants
When a business owner involved in a partnership becomes completely disabled, the company must act fast to prevent the decline of the business. Disability buy-out insurance is available to protect business owners from the repercussions of a lost key partner. For more information about why businesses should acquire disability buy-out insurance, contact the Business Benefits Group.