Within a beehive, there are thousands of hard-working bees. The worker bees spend their lifetime successfully harvesting nectar to convert to honey for their queen, and the queen, in turn, secures the ongoing survival of the hive. But what would happen to a beehive if the queen were to perish?
Ultimately the queen bee would be replaced, but in the short term, the beehive would experience a temporary setback that could risk the survival of the hive.
Now, whilst most businesses don’t have 30,000+ workers like your average beehive, we can agree that the success of a business often depends on key individuals within a business. So, what would happen to a business if that key individual were to lose their ability to work?
What is Key person insurance and what are we protecting?
Key person insurance, also known as key man insurance, is simply an insurance policy that is taken out on the life of a key employee within a business. It is a means of protecting a business from losses incurred should an integral person, who is key to the ongoing success of a business, become unable to continue involvement as a result of death, illness or a significant traumatic occurrence.
The purpose of key person insurance is to help a business to survive the aftermath that follows the loss of the key person. Proceeds of an insurance payout are often put towards:
- finding a replacement for a particular role,
- replacing the revenue generated by the key person,
- clearing debts,
- distributing money to investors, or
- paying severance to employees in the event of the business closing down.
Who are the key people in the business?
A key person of a business doesn’t have to be what Steve Jobs was to Apple, nonetheless, your business may be reliant on an individual who provides your business innovation, handles the key client relationships or manages the internal daily operations of the business.
These people can include, CEO’s, directors, business partners, talented salespeople, essential technicians or those with great business relationships and connections.
What is a buy/ sell arrangement?
A common vehicle for determining what would happen to one’s share of a company if something was to happen to them is through the use of a Buy/Sell arrangement. This is a legal agreement that is put in place to cover the value of shares within a business. Individuals-shareholders can protect the interests of a business by insuring their portion of the business and ensure the ownership is transferred to remaining partners or retained to onboard a new partner.
Consider an example of a company that is equally owned by three directors when one of them dies.
“Mike, Dave and Claire own equal shares in an IT company, FlipCoin Co. Sadly Mike has a terrible accident whilst overseas and passes away.
Mike’s widow Janice is upset as her husband (Mike) was a significant shareholder in this successful business. As Janice is the sole beneficiary as named in Mike’s Will, she inherits his share of the business and has a say in the decision making of the business.
The remaining partners, Dave and Claire, don’t like their new arrangement as Janice has no knowledge of the IT world, no sales experience and doesn’t particularly get along with either of them”.
This example could be avoided if an appropriate buy/ sell agreement was put in place, by a lawyer, for the directors of FlipCoin Co.
How do I know if my business requires Key Person Insurance?
If your company is a sole proprietorship and just employs you and no other or has no other people that it depends on, then you don’t particularly require key person insurance. It will, however, pay to consider personal Life insurance or Income Protection to protect you and your family.
But, if your company is a little more structured and you feel your business may be at risk, here are some of the first steps and questions you should consider in determining the business’s need for key person insurance:
- Categorize the key people of your business and approximately how much revenue they are responsible for. Could you go without someone’s income over the course of 12 months?
- Who fosters the relationships with your clients and can their rapport be replaced?
- Which employees have the most impact when they go on annual leave or sick leave? Are opportunities foregone when they are away?
- Depending on the person’s experience, they may be very difficult to replace. How long will it take to replace a key person? And what revenue is lost at this time?
- Think about the skill set of your employees that may be hard to come by. Do some employees hold higher education or relevant degrees that provide your business with its edge?
Starting a business and watching it grow is an exciting process, and when everything is on its way up, it is easy to forget the risks that face our business daily.
If you feel that some of the information above resonates with your business and you feel you would benefit from a chat, feel free to get in contact at proCFO Perth, because when it comes to business insurance cover, it is better to be 5 years to early, than 5 minutes too late!
About Ryan Addison
Ryan has been a part of the Vision Financial team since 2014 and has completed his Diploma in Financial Planning, and is currently completing the Advanced Diploma of Financial Services (Financial Planning).
Ryan’s previous role as a para-planner has given him a strong foundation in research analysis and strategy development in the fields of superannuation, investment and insurance.