Every year, 12 percent of U.S. workers suffer from a long-term disability. By the time you reach age 65, there is a one-in-five chance you'll have suffered from a disability that affected your ability to work for at least five years.

A disabling injury or illness is even more acute for the small business owner. Disability has been called a "living death," because the disabled person is alive to watch as dreams for a secure future die and as he and his family try to cope. If you own part or all of a business and become disabled, you may have to watch the value of your business plummet if it has to close down altogether, or watch your partners or co-owners struggle to keep the business afloat without your help.

Buy-sell agreements are often called business continuation agreements because that's exactly what they do - they allow closely-held businesses to continue to exist, even if the owner can't physically do it any longer.

Most buy-sell agreements focus on death when funding is provided through life insurance payments (provided the owner is insurable). But disability of the business owner can be even more catastrophic than death, and the chances of suffering a long-term disability before retirement age are much greater than death.

Disability buyouts transfer ownership. Many business owners say that the biggest deterrent to setting up a disability buyout plan has been funding. Fortunately, the life insurance industry has wised up and now offers a variety of options to make disability buyouts possible. The most important innovation is that you can now buy a lump-sum disability buyout policy that makes lifetime monthly payments. The disabled owner gets his money, and the buyers get full ownership of the company.

If you own part or all of a closely held business, it probably accounts for most of your net worth. But how much is it worth if you can't run the business? Unless you have a buyer for your share, it may be worth virtually nothing upon your death or disability. A binding buy-sell agreement requires a business owner to sell his interest to a specified buyer (or buyers) at a specified price or by a specific method of valuation when an event such as death, disability, or retirement occurs. Every buy-sell agreement should have provisions for these three events.

Recognizing death and retirement is easy - it's very clear when the owner has died or has retired. Recognizing a disability can be much trickier. Egos and dollars are at stake here. What co-owner or buyer wants to have to decide the length of time and the extent of the disability before his business partner is considered permanently disabled and a buyout must take place?

So it is better to have made those decisions in advance, and to let a third party make the final determination of disability.

This is where the insurer steps in. The insurance company decides whether the owner in question is disabled. The insurer's decision triggers the buy-sell agreement process. Under normal circumstances, a company will continue to pay a regular salary for a period of time to the owner - usually a year or so, depending upon the existence of employee short-term disability insurance, the size of the business, and the amount of available cash.

For example, let's assume ABC Corp. has two equal co-owners and has set up a buy-sell agreement that is triggered after a year of owner disability. At that point, the disabled owner's stock is sold back to the company. The insurance equals what the disabled owner is owed under the agreement. The company has been valued at $250,000, so his share of the company is $125,000. It's paid in a lump sum or in monthly installments over the next five years.

The buyer (in this case, the company) will usually make a "good faith" down payment of at least 10 percent (in this case, $12,500) and a promissory note will be executed to make monthly payments until the rest ($112,500) is paid off. Those monthly payments are covered by the insurance policy.

The disabled owner's share is purchased over time, and those payments can be made from the insurance policy income, so there is no drain on the corporate cash flow. It is extremely important the new owner also pay the disabled owner interest on the money owed him, at a competitive interest rate that avoids any complications with the IRS.

Complications can arise if the IRS decides the owner has really been lending the company money interest-free (if no interest is being paid) or at a lower-than-reasonable interest rate.

Disability insurance is expensive and there is also no question that setting this up correctly will incur professional fees. The alternative is seeing your business valued at just pennies on the dollar because of your absence.