Creating a Successful Disability Buy-Out Plan

In this industry, we’re planners by nature. It’s what we spend our time doing — working out a plan for a client to help them achieve their dreams. Much of our planning is for the what-ifs. If this event ever happens, what does that mean for my client? We plan for individuals. For families. For businesses.

So let’s discuss the often-overlooked need for a disability buy-out plan. Businesses must plan for the possibility of a partner becoming disabled. And it’s essential that the planning takes place before the disability happens. Either first-hand or through stories, we’ve all experienced tragic events that force businesses to sell to the lowest bidder, discounting years of work and sacrifice. Those outcomes are the result of not having a plan in place in advance.

Just establishing the need for a plan is a great way to start. Ask your clients some basic questions, giving them things to think about should one of them become disabled:

• If one of you buys out the other, what valuation of the business will be used? When it comes to disability, business valuation is very different. Disability business valuation tends to be less than a life business valuation. Follow this initial formula for a tentative disability business valuation:
  1. Add up all incomes, including distributions, from all ACTIVE owners
  2. Based on the type of business (there is some discretion here) use a multiplier of one to five on those incomes
  3. Add in any book value of the business – what is owned versus what is owed
  4. Divide the overall number by the percent of ownership for each owner

Unlike common life valuations, there is not a goodwill multiplier or a gross sales multiplier. Just use the tax documents to follow the steps above and you’re ready to go.

• What elimination period will be needed before the buy-out can begin? This one isn’t quite as straight forward as the valuation but is just as important. One partner might think of a disability as lasting a year; another might define it as 18 months. Setting the waiting period – the time the disabled partner has to get better before the buy-out – in advance is critical to the success of the plan. Disability plans require an elimination period of at least a year but can also extend it to 18 or 24 months.
• What timeframe will be needed to execute and complete the buy-out? If it comes to it, and a buy-out is put into place, how much time will the business need to complete it? And what’s the best way for the benefits to be paid? Most disability plans offer flexibility. Benefits can be paid as a lump sum, as monthly funding (usually available for 24, 36 or 60 months) or a combination of the two — a lump sum upfront, with smaller monthly payments to follow.

Experience teaches us that plans change. But without looking forward, without preparing, we won’t be able to help clients – or ourselves – achieve success.

The key here is to help your client create a formal written plan, regardless of how they decide to fund it. In many cases, disability insurance is the answer. But even if it’s not, just having a plan is what matters.

And as always, the Ash Disability team is here to provide solutions. Just let us know what you’re trying to accomplish, and we’ll help you see it through to paychecks, made possible.