Incapacity of a Business Owner
The financial consequences and a viable solution
This article was written by Gary Opolsky and reproduced from Forum, April, 2002
Consider the following statistics:
• one in four people will
contract heart disease;
• there are a reported
150,000 heart attacks every year;
• ninety-five per cent of
heart attack victims survive the initial attack;
• one in two heart attack
victims is under age 65;
• seventy per cent of
open-heart surgeries are bypass operations;
• one in 20 runs the risk of
having a stroke before the age of 70;
• the death rate from heart
attack and stroke has been cut in half over the last 40 years, but the
frequency of these illnesses has not abated; and in Canada, the risk of
developing cancer is one in 2.4 for men and one in 2.7 for women.
The most typical small business is the sole proprietorship, where the
owner is usually "the business." She has five to 10 employees, and
makes all the major decisions. She has not developed middle management who
could direct the business in her absence. The owner handles almost all of the
important aspects of running the business, from sales to approving the bills.
For many owners, the
business is their main investment, aside from their RRSP and home. The business
may have bank loans, and the owner generally guarantees these loans personally
As soon as the owner has a serious illness, such as a stroke, there can be
serious concerns about the ongoing viability of the company Given that the
owner is "the business," there is a real question as to whether
anyone would buy the business. If there is a bank loan, the bank will likely
secure its position. Overnight, this business owner goes from being in a secure
financial situation to being in a precarious one. How can she keep the business
going if she is not there to provide direction? Sales may be disrupted. Will
she have to use savings to pay the loans, or declare bankruptcy? Financial ruin
is essentially a heartbeat away for this owner.
The other typical small
business situation is a family-run business, or one with a few 
partners. In this case, we assume that some of the functions are
delegated and more than one person has signing authority. Even when these
businesses have a buy-sell agreement that deals with incapacity/disability, it
is unlikely that funds have been set aside to deal with the issue. When one of
the stakeholders has an incapacitating illness, the healthy stakeholders have
to buy out the sick person.
Depending on how the company
is financed, and what functions the sick person fulfilled, the bank may not
feel confident in the group that is now in control, and may call its loan. Many
items cannot be easily converted to cash for original value, and the remaining
partners may not have the wherewithal to raise the money to buy out the sick
partner or pay off the bank loans. Even if they can borrow, it may not be
enough. In some cases, they may have to liquidate part of the business to raise
funds. This is an unfortunate outcome of poor planning. In addition, there may
be conflict between stakeholders and family members, especially if they have
not had an agreement on how to value the shares in this scenario.
In these situations, the
lack of money at a time of crisis is the major problem. Is there a strategy to
protect a business in case a major illness occurs to one of the key people in
the firm, or the owner in a type of policy, smoking status, and health.
Premiums vary between companies. For example, the premium for a $100,000
renewable, 10-year term policy for a 45-year-old non-smoking male is about
$850. The same policy with a locked-in premium to age 75 is about $1,400.
When an owner of a small business suffers an incapacitating illness, the financial consequences can be catastrophic. You can help your clients do contingency planning for a major illness by implementing a critical illness insurance program.
Other
articles included this month:
Selecting an Executor: Know Your Options
Return to Jul-Aug
2002 $$$ Maker Report