Even the most successful ventures face a hidden risk that could quickly see the business unravel. If you have an equity stake in a small or medium enterprise, you need to recognise this risk and take steps to protect the business.
Australians are an entrepreneurial lot, with around 2.17 million actively trading businesses. Fewer than 3% of these have more than 20 employees, highlighting the importance of small and medium-sized enterprises (SMEs) in the national economy.
However, even the healthiest SMEs face a threat that many owners are unaware of, often until it's too late. That risk is the loss of a “key person”.
The fact is, many businesses rely heavily on the skills and expertise of one or two key people, often the business owner, but sometimes a leading employee.
If something were to happen to this key person through illness, injury or death, the business could quickly unravel, potentially leaving dependents including family members and business partners, in serious financial trouble.
It won't happen to me
Of course, it's human nature that we tend to think “it will never happen to me”. But the fact is none of us are immune from the unexpected.
The loss of a key person within a business can have a profound impact, especially as it's common for a single person to be “the brains” of the organisation – perhaps the chief driver of sales or the main client contact.
We see this even in larger companies. The late Steve Jobs, for example, was synonymous with the success of Apple Inc. The Virgin brand is heavily reliant on the personal goodwill of founder Sir Richard Branson (who is still very much alive!).
SMEs can struggle with the loss
While big corporations may have the resources to withstand the loss of a key person, SMEs often don't.
The loss of a leading figure can see sales decline, profits fall and cash flow dwindle. Sadly, the end outcome in some instances may even be insolvency. In the worst case scenario, employees lose their jobs, business partners are left financially skewered, and the family of the key person can be left helpless as a loved one's legacy, and a valuable asset, withers on the vine.
If business loans are secured by the key person's personal assets such as a family home, the financial fallout can be particularly devastating.
Fortunately, there are ways to avoid the financial challenges associated with the loss of a key person and one of the options that could be suitable for your business is “key person” insurance.
How “key person” insurance works
“Key person” insurance (sometimes known as “key man” insurance) is designed to protect a business from the financial impact of the loss of a leading person within your enterprise. This doesn't necessarily have to be a proprietor, it can be an employee.
Broadly speaking, a payout can occur if the key person passes away, develops a serious illness or is unable to work due to injury. This payout provides funds that can be used to tide the business over until a permanent replacement for the key person is found, or, if you choose, until the business is sold. Either way, it can be a valuable injection of cash at a time when it may be badly needed.
With a wide variety of “key person” products available, it stands to reason there is a great deal of variation around this type of insurance. The payout for instance may go to the business itself or to a nominated individual. What's right for your business depends on the structures you have in place. Similarly, the cost of premiums varies widely between providers.
Can your business afford the risk?
The main point is that no business can afford to be openly exposed to risk. I can explain some of the risk factors to help you decide which ones your enterprise might face, and how these might be mitigated with “key person” insurance.
Importantly, I can work with you to determine the level of key person cover that would be appropriate for your venture, and source the policy appropriate for meeting your business' needs.
It's worth noting that the tax deductibility of “key person” insurance premiums depends on how the policy is structured, so it can be costly to arrange key person cover without the assistance of expert advice.
We believe that “key person” insurance should be a part of your venture's succession plan. Contact my office today to find out how you can help to protect your business interests, and give those who are close to you and that business valuable peace of mind.