How long would your business continue if you weren’t working in it? One month, two months, maybe three?
At least 40% of all small businesses have a critical dependence on a key person for ongoing business and balance sheet solvency. Is your business one of the 40% and if so, do you have a risk management plan in place to protect your business against key person risk?
Key Person Protection is a planned response to assist a business to maintain its financial commitments when a key person unexpectedly dies or is seriously incapacitated. It is designed to minimise the likelihood of insolvency and to protect the value of the business.
Did you know that you have a high chance of becoming disabled for longer than 6 months?
The statistics for disability is more significant than most of us realise. Out of 415,000 males in New Zealand between the ages of 30 and 45, 12 out of every 100 will experience at least one period of disablement lasting six months or longer. A further 8 out of every 100 will be disabled for at least one period lasting 12 months or longer.
The statistics for women are even higher. From a group of 433,000 females aged between 30 and 45, 18 out of every 100 will experience at least one period of disablement lasting longer than six months and 12 out every 100 will be disabled for 12 months or longer.
The downstream effects of key person loss are often predictable and to a reasonable extent measurable ahead of an event.
How would your absence affect revenue? Debt repayment? Personal Guarantees?
The most obvious short-term effects (within two to six months) is a loss of revenue. If the key person is directly responsible for generating revenue and cannot be replaced immediately with someone who can maintain your relationship with customers and clients, income will start to decline.
In many small businesses it is the effort of one or two people, which keeps a business above the solvency line. If your revenue is declining you may not be in a position to meet the financial obligations of the business. Inability to service debt obligations, over which you have personal guarantees, will put both your business and personal assets at risk.
Are you replaceable? At what cost?
The loss of a key person will often give rise to an immediate increase in costs due to the need to recruit and train a replacement (if it is a viable option). Typically, the direct costs will be 15% - 20% of the salary. In addition to recruitment costs the business may also have to face the extra expense of meeting a market rate salary. Many small businesses do not have cash reserves aside to meet these unexpected contingencies.
If the key person has the main relationship with customers, suppliers and creditors you will need to consider:
If your customers will want to do business with the replacement
Can someone be found with the necessary skills?
Will your creditors give you the same terms of trade and will pressure come to bear on credit facilities.
Consideration of these issues will assist you to determine if your business will be able to trade on despite the loss of the key person or whether you would be best to plan to wind the business up.
If you judge it is not viable to trade on, your Key Person Protection strategy will need to ensure there are sufficient funds available to pay creditors, clear all debts thereby releasing personal guarantees and meet the wind up costs. This enables you to walk away without placing your personal assets at risk, or being forced into bankruptcy or insolvency.
If you believe it is possible to transfer the relationship and skills to another person, trading on may be a viable option. However, you need to plan to have funds available to:
Cover short term loss of revenue
Meet recruitment and training costs
Reduce debts to ease pressure on the cashflow
In a perfect world all businesses would have a succession strategy in place to reduce their dependency on a key person. However, this is not always possible and if it is, it may take years to develop. As a business owner you therefore need to put in place contingency planning for the worst-case scenario for your present situation.
Key Person Protection insurance provides a business with funds to manage the financial risk arising from death or disablement of a key person.
The appropriate type and level of cover should be assessed for your business based on your unique needs. Structured correctly, it will minimise both your business and personal risk and give you the greatest chance of surviving a crisis in a timely and orderly manner.
“Think of the worst thing possible that can happen... believe it could happen... and protect yourself against it.”
Author: Cecilia Farrow, Managing Director of Triplejump Limited. Triplejump is New Zealand’s first independently owned personal and business risk advice Franchise Company, unaligned to any insurance carrier. She is the recently retired Director of the Institute of Financial Advisers and past Chairperson of the Auckland Branch