by Todd Gurley, Senior Management Consultant
Owners of closely-held businesses push their people (and themselves) hard every day to achieve important goals. Owners are singularly focused on making their businesses a success. As they grow their businesses, they often do not think of the “unthinkable” — “What happens to the business (and me) if I lost one or more of my key employees due to an unexpected death”?
This story is not about the positive exit strategy, such as selling your business and retiring comfortably. This is about the unthinkable: the loss of a key person or persons in your business that creates “exit implications” not contemplated in your long term plan. So, if that key person unexpectedly dies the company’s future may hinge on that unthinkable moment.
The harsh reality is “key people” are lost every day due to death or a fatal diseases; and after the loss of a key person, more than 80% of small to medium size businesses are out of business in less than three years. Every closely-held small or medium size business has at least one key person it can’t afford to lose. Maybe it’s the founder, CEO or CFO.
Or, maybe it’s the top sales person who has bonded with your largest customers representing over 60% of your revenues. Ponder that scenario for a moment.
Most owners can’t even stand it when key people go on vacation, much less the thought of them never coming back.
Of the 20% of companies who survive the loss of a key person, most have of those companies have some type of insurance on the lives of their key people.
Remember, key people are replaceable, but the company needs time and money to make it happen. There are four things a company must consider in this process:
1. Who to insure;
2. What type of insurance;
3. How much insurance; and
4. What company to purchase from.
The “who” is straightforward? If the loss of a person would have a significantly negative impact on operations, customers or financials then they should be insured.
The “what” gets a little more involved. There are two broad types of insurance—term and permanent—that will cover the vast majority of situations. Below is a brief explanation of each and some options to consider:
Term insurance for a fixed period of time. It’s the cheapest and easiest to get. Consider it as renting insurance. It’s pure insurance for a fixed period of time with no build-up of cash value. A policy for $500,000 will pay the company $500,000 at the insured’s death with generally no tax implications (always consult your tax advisor first).
Permanent insurance for “death” purposes. Your options (and the complexity) increase significantly with permanent insurance. Consider permanent insurance as just that: you own the policy for life regardless of what health conditions may arise in later years. These policies offer both insurance and an investment component, generally called “cash value.” Unlike term, part of the premium pays for the insurance component of the policy and part pays for the investment component of the policy. The cost of permanent insurance is significantly higher than term insurance, but its purpose is to ensure you for life rather than a fixed period. Depending on the kind of permanent policy, the cash value can be invested in different ways.
Permanent insurance for “employee retention” purposes. Insurance for employee retention purposes are important for four reasons.
- The policy protects the business if the employee dies.
- The build-up of cash value can be used, for example, as a long-term employee retention incentive for the employee to stay with the company. If the employee meets certain requirements the company can transfer the policy to the employee along with its cash value. While there are tax implications for the employee with this transfer, there are strategies to minimize its impact.
- When you sell your business, buyers want to retain a stable management team. Using permanent insurance for a part of your employee retention program adds value creation to the business giving you an opportunity to sell your business at a higher price than you normally could if you did not have an employee retention program.
- The company can protect itself with this type of policy in case the employee leaves early by recouping some if not all of the premiums it paid from the cash value.
The “how much” is a balancing act among what you believe to be the true cost to replace the person (s), the number of key people to be insured, keeping the business stable during a transition and how much the company can afford. Some owners want insurance coverage from 10 to 15 times salary for each employee covered. This “peace of mind” relieves one more pressure point on the owner.
Not to be ignored in this process is the person who is helping you make this decision. The majority of agents who sell life insurance are not adequately trained or qualified to help businesses make these complex decisions. You need an advisor who understands your business — it strengths and weaknesses of not only your people but of the business itself.
When you purchase, buy from the highest rated carriers. Before you buy from any carrier, press your advisor to provide background on each carrier from rating services like A.M. Best, Standard and Poor’s and Moody’s.
Let’s end with a question: When is the cheapest time to buy life insurance?
Do it for the health of the business that you have worked so hard to build.
Mr. Gurley is a senior management consultant for GEM Strategy Management, Inc. with a broad range of leadership skills and experience from start-ups to Fortune 10 companies. Mr. Gurley’s subject matter expertise includes helping clients develop and execute growth and expansion strategies; strategy implementation; operations management; strategic planning and execution. He is co-founder of Redbird Advisors, a national marketing and consulting firm providing value-added insurance services to independent insurance firms. Redbird Advisors, provides marketing program support, training/education, sales and management mentoring and develops business expansion strategies. 970.390.4441