Succession planning is one of the basic responsibilities of the business owner. After all, the owner’s family, partners, shareholders, suppliers, vendors, and in many cases, employees and their families all rely on the business’s continued viability as a going concern, to a greater or lesser degree. And of course, for the owner’s family, that dependency can be great, indeed.

Life-Changing Event

Which means that the sudden death or disability of a business owner or partner can be a life-changing event for a variety of reasons:

  • If the business continues, surviving partners may not have the skills or contacts to replace the deceased or disabled partner.
  • Heirs may not have the knowledge, skill sets or interest to take over for the deceased owner.
  • The disabled owner and his or her family may still need to draw income from a company they still at least partly own but is not operating at full capacity anymore because of the loss of the key individual.
  • They will need to draw income from the business, even though the deceased or disabled shareholder/manager is no longer contributing – possibly causing resentment among surviving partners and their families.

Protection Against Death

Arranging protection for a deceased owner’s family is generally straightforward: All shareholders agree in advance to buy out the interests of a deceased shareholder’s heirs at some reasonable valuation. If the cash to do so is unavailable, every partner owns a life insurance policy on every other partner, or the company itself owns a life insurance policy on each owner or key individual. The cash death benefit enables the surviving shareholders or partners (or in some cases, a colleague or competitor) to buy out the interests of the late individuals’ heirs.

Protection Against Disability?

But what happens when the key individual isn’t dead but is disabled? In that case, things get a little more complicated.

Most disability insurance policies are designed to pay an income to replace the lost income due to an individuals’ disability. But in the event the disabled owner can no longer contribute to a business, the remaining partners still have a heavy need to buy out the interests of the disabled individuals’ family.

Buy-Sell Agreement

Fortunately, with a bit of planning, it is possible for a buy-sell agreement to work well in the case of a disabled owner or partner. This protects the disabled owner and his family, of course, for it enables them to be justly compensated for their share of the business. But it also protects non-disabled shareholders, as well, since they won’t have to divert cash from business operations to provide income for the disabled partner, and they won’t have to worry about their former partners’ heirs, family members or attorneys becoming aggressive and meddlesome in the business.

It also protects the surviving business owners by keeping things in-house. If a disabled partner is forced to sell his or her interest to an outsider, he may have to sell at a steeper discount and not get full value for his share of the business. Meanwhile, the remaining partners will have to deal with a partner who may not care for the business as a going concern as they do, or who may have few or no skills to bring to the table, other than a frequent demand for dividend income.

The business or shareholders can fund a buyout agreement with a disability policy, just as easily as a life insurance policy, though it requires some planning and coordination of benefits.

Tip: You may want to include a business re-entry provision in the buy-sell agreement. That is a provision that allows a previously disabled shareholder or partner to buy his or her way back into the business if he or she has recovered from the disability.

Key Points

A disability agreement should guarantee that non-disabled partners or the business will purchase the business interests of the disabled partner at a specified price, or using a specific valuation metric, such as ‘1x previous years’ revenues’ or some other reasonable and mutually agreeable method.

This allows the disabled partner to convert his or her interest into cash.

The disabled owners’ family need not get involved in the business at any point – generally saving a good deal of friction and strife. Remaining owners are guaranteed continued control and no dilution of their interests after the buyout.


As mentioned, most standard disability policies pay benefits in the form of a stream of income. However, it is often possible to structure a policy to pay a lump-sum payout as well. Businesses can use either a stream of income, a lump sum, or both to structure a buyout plan for a disabled shareholder or partner.


Expect the insurance company to require an executed buy-sell agreement before policies are issued. Also, generally, all full-time owner-employees must apply for coverage – and benefits are limited to full-time owner-employees.

For underwriting, carriers will probably ask for 1-2 years’ worth of income statements.

Most businesses are vastly underprotected against the risk of a severe disability for one or more full-time owner-employees – even businesses that have a workable buy-sell agreement in place in the event of the death of a business owner frequently neglect this important part of planning. But for individuals under about age 45, disability is a more frequent eventuality than death. Don’t leave a gaping hole in your business succession plan. Start planning for the disability contingency today.