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Only on The Financial Contract Every Practice Must Have

Posted: July 13, 2011

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C. Benefits to family members. For a deceased owner’s family, the existence of the buy-sell can assure the family or estate a liquid asset rather than an interest in a private business. In a medical practice, physicians cannot leave it to their families unless they too are physicians, essentially not leaving their family any interest in the business. This is the only business that has this consequence. This is why a practice owner must have a buy-sell agreement in place with their partners clearly stating what each partner’s family will receive from the surviving partner upon time of death or disability. This is fair and it is the right thing to do.

Funding the agreement

Where the agreement contemplates a buy-sell transaction at the time of an owner’s death or disability, insurance policies are generally recommended to fund the transaction. There are many reasons for this, including the following.

  • Insurance policies pay a pre-determined amount, with proceeds available at exactly the time when they are needed as a funding source.
  • Proceeds will be available regardless of the financial state of the practice at that point (so long as premiums have been paid).
  • The business “leverages” the cost of premiums to create the proceeds; thus, it costs the business less to buy insurance than to save money in a special buy-out fund.
  • The economic risks of early death or premature disability of any owner are shifted to the insurer.
  • Insurance proceeds are paid to the family income-tax free.
  • If retirement is also a contemplated buy-out event, whole-life or universal-life policies can allow large cash values to accumulate, providing the retiring owner with a cash-out.

If the payment contemplated under the agreement is not a lump sum cash payment at closing or is a periodic payment other than through a disability insurance policy, it is important to consider some type of security arrangement for the departing owner. These might include personal guarantee from remaining owners, mortgages or security interests in real estate, a bank standby letter of credit, or even collaterally assigned life insurance. The key here, of course, is what is negotiated upfront between the various owners—ideally—before there is an idea of who may die, be disabled, retire, or divorce first. This way, each owner will be unprejudiced in determining a fair buy-out.

Disability: The overlooked reason
for the buy-sell

Buy-sell agreements receive a lot of attention when used to deal with the death of a business owner. However, something equally important and much more likely is that before any owner dies, he or she will become permanently disabled.

Business owners may need two-way protection in the event of disability. First, they have to consider providing for adequate income to meet routine personal expenses including increased medical expenses through a disability income program. Then, they must protect the value of their ownership interests, which can most easily be accomplished by expanding a buy-sell agreement to cover the risk of total disability.