The risk of becoming too sick or injured to work, before retirement age, is much more prevalent than death. How would a business partner handle maintaining their business interests if they became physically or mentally handicapped?
The partnership is one of the three most commonly used types of business organizations. A partnership is an association of two or more persons who carry on a business, as co-owners, for profit. It is more complex and usually requires more legal formalities than a sole proprietorship.
The law of partnerships is relatively uniform; most states have based partnership statutes on the Uniform Partnership Act (UPA). The UPA states that each partner has a fiduciary relationship to the partnership and must act in good faith and for the benefit of the partnership.
To prevent problems when a partner dies or leaves the partnership for any reason, a partnership agreement often includes a buy-sell agreement provision. By law, this provision must be in place when the partnership is created. It describes the manner of compensation for the survivors of a deceased partner or for the withdrawing partner.
Often, partners provide for the possible death of a partner by taking out a life insurance policy on the life of each partner. The policy is made payable to the partnership or to the surviving partners, enabling the partners to pay the amount required in the buy-sell agreement to the survivors of the deceased partner, and remaining partners are financially able to continue to do business.
The same rationale for using a life insurance policy to fund a buy-sell agreement upon death applies to using a disability insurance policy to fund a buy-sell agreement upon total disability, whether permanent or temporary.
Rationale for active business owners
- Acquire business interest of disabled owner at a fair price
- Maintain ownership and control
- Smooth transition of ownership
- Transfer the decision of when the definition of "total disability" is met to a third party
Rationale for the disabled business owner
- Proceeds for the sale of his/her share of the business is received
- Eliminates future worry about business value fluctuations
- Taxed only on the gain from the sale of the business, often at more attractive capital gains rates
Definition of disability
The definition of disability to use in the disability buy-sell agreement can be the definition contained in the insurance policy that will fund the buy-sell. This transfers the risk of defining disability from the active business owners to the insurance company, avoiding potential disagreements among all the partners.
Disability buy-sell insurance matters because a partner's disability could make continued ownership of a partnership all but impossible.
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