In early 1990, a group of 6 orthopedic surgeons formed a partnership. In an effort to secure financial protection for the company, they hired an attorney to draft a contract. One section of the contract required the surgeons to buy out a partner if one of the partners became disabled.
A year ago, one of the 6 was in an accident that required him to stop working. The other partners turned to the contract requirements in order to buy out the disabled partner but quickly realized that a mechanism to fund the buy-out did not exist.
It was at this time that they decided to consult a financial representative, who suggested a disability buy-out (DBO) policy to fund their buy-sell agreement.
A buy-sell agreement is a legally binding, mutual agreement among business partners that establishes a buy-out price at the formation of the partnership that is fair to both the disabled associate and the remaining owner(s). A DBO policy can help business owners, particularly small business owners, who find themselves in a variety of situations such as:
o One partner becomes disabled and cannot actively contribute to the business but continues to collect a salary. Eventually, the other partner(s) hires a replacement to take on the disabled partner’s responsibilities. Consequently, there is a dual cash drain on the business.
o A disabled partner becomes more financially conservative in order to protect his/her investment. As a result, growth opportunities are missed and resentment and conflicts arise among the partners.
o The disabled partner is unable to pay his/her medical bills or maintain the previous standard of living and decides to seek a quick sale. The other partner(s) could be forced to sell at a discount, or may not be involved in selecting the buyer, which could lead to a bad fit for the company.
In each situation, a DBO policy would fund a business’s buy-out agreement and pay benefits to the healthy partner(s). It reimburses the money spent on purchasing the business interest of the disabled owner.
Few small businesses develop buy-sell agreements at the formation of a company. Those that do implement such an agreement rarely outline the funding requirements of such a provision. In addition, many business owners completely disregard disability as a possibility when, in fact, it is quite common.
Most people believe they have a minimal chance of becoming disabled in their working years. However, the actual facts are startling. (See box.)