When partners and business owners discuss succession and contingency planning, the conversation eventually includes death, but rarely disability.
When the original Articles of Incorporation and accompanying Shareholders Agreement are prepared, the provisions to transfer ownership to the surviving partner(s) is invariably included.
In small businesses where each owner is required to also invest significant time, effort and skill to the enterprise, the loss of an owner to disability is rarely anticipated or accounted for in business planning.
For the sake of the business it doesn’t matter ‘why’ the owner is unavailable; it matters more that the former partner or owner is unable to continue their contributions to the firm.
What you need to know
Dying “on the job” does occur, but not nearly as often as you may imagine, nor nearly as frequently as it did generations ago. There is actually a very low statistical rate of working-aged people dying. For example, out of 1,000 Canadian men aged 55 to 59, only 6.2 of them will die in a given year, according to StatsCan. Also, looking at each year of the 40-year period from age 25 to 64, the highest likelihood of dying in any year is 1.26% for men and 0.08% for women.
In total, over the 40 year working life, 12% of men and 8% of women will pass away at a working age (according to StatsCan’s 2013 data and Advisor Research Group analysis of it).
For that same working age range, men and women in Canada experience significantly higher levels of disability. 21.2% of men and 24.2% of women aged 25 to 64 experience a disability.
StatsCan, who developed the 2013 Canadian Survey on Disability, uses the following definition pf the term: anyone who reported being “sometimes”, “often”, or “always” limited in their daily activities due sot a long term condition or health problem.
What happens to your multiple-owner business when one or more owners becomes disabled or sick?
Death of a partner is typically written into a partnership or shareholders agreement, but the inability to continue performing as a worker/owner is often not planned for. However, this type of incapacity can lower the value of a business by resulting in loss of revenue, lowered capability, and weakened client/supplier relationships.
Without the ability to contribute in the day-to-day activities of the business, a disabled owner may need to sell their share of the business to realize a nest egg. Unfortunately, the other owners may not be financially able to participate in an unplanned or early buy out, and issues could arise if the disabled person is partnered with “the wrong kind” of fellow owners who may not negotiate in good faith.
It is much better, as stated earlier, to include disability in the Shareholders’ or Partnership Agreement. There are two basic methods to utilize Disability Insurance:
1. Cross Buy/Sell - every business owner owns a DI policy on each of their co-owners
- The premiums aren’t deductible as an expense by the business
- There are no tax consequences for the insured person related to the payment of benefits
- The disability benefits are paid tax-free to the policy owner
- The policy owner purchases the insured person’s shares or partnership stake
2. Redemption Buy/Sell - the business (only corporations) owns a DI policy on each owner
- Works best when there is a limited number major shareholders
- The premiums aren’t deductible and are not treated as income by the insured person
- The disability benefit is paid to the corporation
- The corporation then redeems the disabled shareholder’s shares
- Any amount paid to the disabled shareholder that is greater than their paid-up capital is treated as dividend income
The nature and details of your plan should be tailored to you and your fellow owners, and be established by your lawyer, accountant and me - your financial advisor - in writing. Additionally, spouses and adult children who may have taken over the business (or at least your portion of it) should be informed of your plans.
A significantly higher percentage of working-age Canadians are affected directly by disability than by death.
Don’t let a simple oversight stop you from protecting yourself, your business and your family. Like planting a tree, the best time to purchase insurance was 10 years ago.