What Happens if a Business Partner Dies or Becomes Disabled?

This is a question that business partners and co-owners in limited liability companies (LLCs) often fail to address. You start a business, and everyone is committed to its success. All the partners are healthy and vibrant, and you are working 16-hour days just to get the business off the ground.  So, the last thing you need to worry about right now is the death or disability of one of the owners, right?

Actually, this is exactly the time to address issues like these. Things happen over time; people age, health conditions develop, people get in fatal car accidents, and a number of other adverse events invade our lives. And if something were to happen to one of the owners or partners down the road, this could be disastrous for the business – if you are not prepared ahead of time.

If a business partner were to die or become disabled, there are a number of potential scenarios that would ensue:

• A Family Member Takes the Partner’s Place: Maybe you will be fortunate and someone in the partner’s family will be suitable to step up and take their place. This could be a spouse, child, or possibly a sibling.  For this to work, however, the new person has to be qualified to take on the duties of the partner they are replacing and be acceptable to the other owners. It is very rare that this type of situation works out, but it is great when it does.
• A New Partner is Brought In: If there is no one in the family that can come in to work for the business, maybe you can find an outside person to buy the partner’s shares from them or their family. Again, the new partner would have to be qualified and acceptable to the current team, and motivated to join the team. This is often a very tall order, and definitely not something you should count on happening.
• The Other Partners Buy Out the Partner who is Gone: One of the most likely scenarios when one of the owners departs is that the other partners will want to buy out their interest in the business. This is often the cleanest way to do it, because you do not have to deal with someone new coming in and not being sure whether or not they will work out. To exercise his option, however, those involved will need to find a way to accurately value the outgoing partner’s shares and be able to raise the funds necessary to buy them out. Both of these issues can cause serious complications if they are not addressed in advance of an event like this happening.
• The Business Dissolves: The worst-case scenario is that there is no one to step in and replace the partner, and the other owners are unable to raise the money needed to buy them out. When this happens, the owners may have no choice but to dissolve the business, sell it to someone else, or sell off its assets. Having to sell or shut down could be devastating for the remaining partners who have put their heart and soul into building the business and want nothing more than to see it continue operating.

The Importance of Creating an Operating Agreement

Rather than being at the mercy of future circumstances, business partners are much better off addressing scenarios like the death or disability of a partner in advance. This is done by crafting a partnership/operating agreement. With this type of agreement, you would be able to set out the terms and conditions by which one of the partners could sell their shares. For example, you could restrict ownership to only the other remaining partners, or require approval of all partners before someone from the outside is allowed to buy in.

For the specific issue of a partner dying or becoming disabled, you could have a predetermined way of valuing their interest in the business, and a buyout clause stating that the other partners have first right to purchase their interest. To finance this purchase, the business could obtain keyman insurance on each partner.  

Keyman insurance is life insurance that pays the business a death benefit if one of its owners or key members passes away. Some insurers also offer the option of adding disability coverage to the policy as well. With this type of insurance in place and predetermined terms and conditions regarding a partner buyout, partners never have to wonder what would happen if one of them dies or becomes disabled. They would already have a plan in place and the means by which to carry out that plan.

Operating agreements can be used to address a wide range of other issues related to ownership and operation of the business as well. For example, they can be used to decide how much money each partner is required to put into the business, the responsibilities of each partner and what areas of the business they are in charge of, when and how profits are to be distributed, time off and family leave parameters, the salary each partner is paid, and many others.

Although all the partners are usually working a lot in the beginning, there may come a time when one or more partners decides to take a step back, take time off, or work less. When this is the case, those who are putting in more work will most likely want to be paid extra to compensate for this. And this is another important area that operating agreements can address.

What is the Best Way to Develop an Operating Agreement?

An operating agreement is not something that can be thrown together on the fly. It is important to put a lot of thought into it, and the partners should take the time to discuss the essential areas that they want to have included. You could do this on your own using one of the boilerplate templates that you can get online, but this is probably not the best idea. Your business is unique, and the language in your operating agreement should be tailored to address your specific needs and circumstances.

Business partners often find it helpful to bring in a professional mediator to help them craft their operating agreement. Mediators are outsiders who have no vested interest in what the agreement will ultimately look like, and this gives them a perspective that none of the partners have. A mediator, and particularly one who also has extensive business experience, can also provide insights into areas and issues that the partners may not have considered. This helps them put together a more comprehensive agreement that effectively accounts of for all known eventualities.