Posted by Amy Carbone on Jul 17, 2023 9:00:00 AM
No one likes to think about death or disability. These are topics many people tend to shy away from in their thinking, conversation, and planning. Many practice owners minimize the chance of death or disability but the impact on the practice and the partners can be significant in the unfortunate event that this does happen. When two or more business partners are involved in a venture, this topic is among the more critical to address. Thankfully, a legal vehicle known as a buy-sell agreement can help define the ‘what ifs’ of such scenarios.
What Is a Buy-Sell Agreement?
A buy-sell agreement, funded with life insurance or a disability buy-sell insurance, or both are critical for dental practices that are owned in partnership with another individual(s). A buy-sell agreement establishes concrete steps as to what would happen in the event of the death or disability of a partner.
The agreement, however, only provides the legal framework for the series of wishes that are to be followed. For it to become a functional succession tool, the agreement needs to be funded with life and/or disability insurance. Life insurance is used to fund an agreement that is triggered by a partner’s death; a disability buy-sell agreement is triggered by a partner’s disability and is funded with disability insurance.
Why Have a Buy-Sell Agreement in the First Place?
Undoubtedly the death or disability of a partner will be emotionally trying for the surviving partner(s), their families, and the practice. A buy-sell agreement eases the financial stress that would exacerbate an already trying situation.
Having a solid agreement in place is critical for any partnership and having the appropriate insurance to fund the agreement may save you, your partner, and your families huge headaches in the long run. The agreement is put into place when all partners are alive and well. Each doctor is insured under a separate policy: both life and buy-sell disability insurance. Everyone agrees to everything. As obvious as this may seem, having all these questions settled ahead of time provides for ease later.
What Issues Does a Buy-Sell Agreement Address?
Here, in short, are several good reasons why you would want to work with an attorney and accountant to establish a buy-sell agreement:
- Establishes ground rules for what would happen if a partner is disabled or dies.
- Establishes, in advance, how the practice value will be determined in such an event.
- Mitigates the financial issues that may arise. For example, it may eliminate the need for the surviving partner to secure a bank loan in an already stressful time, especially if the practice is losing the gross production of a practicing dentist.
- Offers certainty for the continuity of the practice.
- Mitigates conflict among surviving family members and partners, because the funds are available, and a plan is already in place.
Now, let’s look at how insurance helps fund the agreement.
Buy-Sell Agreements: Funding With Life Insurance
Scenario One: A Partner Passes Away
In the event of the death of a partner, it’s important to have a plan as to what would happen to the business. Not only will the surviving partner likely not want to be in business with the deceased partner’s spouse or estate, but state laws pertaining to practice ownership may further complicate things.
Likewise, the deceased partner’s heirs may have no interest, ability, or desire to get into running a dental practice. Having a buy/sell agreement in place sets the rules in place as to what will happen to the practice now that one of the partners is deceased.
When life insurance is obtained in order to fund a buy-sell agreement, it’s obviously done while both partners are alive and can come to an agreement on the valuation of the practice, and on a sale price if one of them is no longer alive. Say there’s a partner A and a partner B, who agree on the method of valuation for the practice. Either both partners acquire life insurance for the said amount and designate each other as beneficiaries, or the business itself becomes the owner and beneficiary of the life insurance proceeds.
Say that Partner B dies prematurely, which is most unfortunate for everyone involved. Thankfully, the buy-sell agreement sets forth how much the sale price of the practice will be and what will happen next. The life insurance proceeds on Partner B’s life are used to purchase B’s share of the business, so that partner A can continue, and the business can operate without further (financial) disruption.
But what if a partner doesn’t die? What if a partner is disabled? What happens then? A buy-sell agreement should have a provision in place for when a partner is disabled.
Funding The Agreement With Disability Insurance
Scenario Two: One Partner Becomes Disabled
Again, we go back to our two partners, A and B. This time partner A is disabled in an accident, and it doesn’t look like a return to the practice is likely. But who’s to tell? The buy-sell agreement kicks in and sets forth the ground rules for the buyout. In the agreement, it is clearly stated — and previously agreed upon by both partners — that after a fixed period, partner B can buy out partner A, funded in whole or in part with the policy. The time between disability and the ability to purchase the practice varies; it could be a few months and is typically a year.
Disability buy-sell insurance policies typically require that the disability last for twelve months before any benefits are payable. Each practice will come to its own conclusion as to what that needs to be. This may help mitigate potential issues if the disabled doctor is convinced that he/she may be able to return to the practice when it is obvious to the other partners that it is not a possibility.
Understand Your Options With Buy-Sell Agreements
Disability cases are not always as clear-cut as when a partner passes away. Obviously, if a partner dies, you know they are not coming back. A disabled partner, on the other hand, may potentially return to the practice. Or they may think they want to return to the practice, even if it may not be feasible in the long run. This makes the disability scenario more complex to navigate.
If you own a disability buy-sell agreement on the partners, it is the insurance company that ultimately determines whether the injured/ill partner is totally disabled and unable to return to the practice based on the definition of total disability in the policy. A financial advisor can help you navigate this difficult situation, contact us for more information.
About Treloar & Heisel
Treloar & Heisel, an EPIC Company, is a premier financial services provider to dental and medical professionals across the country. We assist thousands of clients from residency to practice and through retirement with a comprehensive suite of financial services, custom-tailored advice, and a strong national network focused on delivering the highest level of service.
