For many small and medium-sized businesses, a few key individuals drive growth and profitability. Which raises the question – what happens to the business should one of those key individuals die suddenly?
While thinking about your own, or a key employee’s death, is not pleasant, business owners need to plan to find ways to mitigate the damage that can be caused by the sudden loss of a key person. Fortunately, there is a tool that can help these business owners ensure that their business can continue through these situations.
Read on as we explain key person insurance and how it can help ensure your business survives, even when faced with the unthinkable.
Clarity: What is Key Person Insurance?
For many small and medium-sized businesses, the sudden loss of an owner or other pivotal employee might cause significant disruptions, including:
- Loss of Revenue: If the key person participated in revenue generation, such as sales, their absence could lead to a decline in revenue for the company.
- Increased Expenses: Replacing a key employee can be an expensive endeavor when you account for all the costs associated with recruiting, hiring, and training a replacement. Plus, there may be additional costs related to potential interim management expenses or outsourcing of those employee functions.
- Confidence Erosion: The sudden loss of a key figure in a smaller company might cause clients and employees to fear that the company has become unstable and wonder if it has a viable path forward. This could further harm the company by leading to a loss of other personnel or a reduction in revenue as customers choose not to do business with the company.
- Strategic Delays: The sudden loss of a key person may halt or delay major projects or strategic initiatives that the individual was leading.
A potential way to mitigate these issues is key person insurance, which is a life insurance policy that a business takes out on the life of a key employee. This person is usually someone whose skills, knowledge, and experience are essential to the company’s success, such as a CEO, founder, top salesperson, or a key technical expert. If the individual dies while employed, the policy provides a death benefit to the company, helping to mitigate the financial impact of their loss.
Key person insurance offers several potential benefits to a company that can address the issues enumerated above. These include:
- Financial Security: The death benefit from a key person policy provides immediate liquidity to the company, helping it to manage cash flow and cover additional expenses incurred due to the loss of the key employee.
- Business Continuity: With that liquidity, the business can continue to operate while finding a suitable replacement for the former employee.
- Creditworthiness: Key person insurance can help a company even if the policy is never used. Lenders and investors often view key person insurance as a sign of prudent risk management, enhancing the company’s creditworthiness.
- Peace of Mind: In a similar vein, key person insurance provides business owners and other stakeholders, such as employees and clients, with the assurance that there is a safety net in place.
At C3 Financial Partners, we work with business owners and their advisors to identify potential liabilities that need to be addressed if their business should suffer the loss of a key person.
Confidence: Implementing a Key Person Policy
There are two main questions for a company choosing to implement key person policies – who is a key person and how to structure the policies?
To determine who qualifies as a key person, it’s essential to assess the roles and contributions of various employees. Typically, a key person would be someone whose absence would significantly disrupt business operations. This could include:
- Founders and Owners: Their vision, leadership, and strategic direction are often irreplaceable, especially in startups, family businesses and other closely held small and medium-sized businesses.
- Executives: Top executives like CEOs, CFOs, and COOs who play critical roles in decision-making and strategic planning of a company.
- Top Salespeople: Revenue is the lifeblood of a company. High-performing sales executives whose relationships and networks are integral to the company’s revenue.
- Technical Experts: Individuals with specialized knowledge or skills that are difficult (and expensive) to replace, such as lead engineers or chief scientists.
Once a business has determined who should be covered, the process of obtaining the necessary coverage can begin. A key factor for a business to decide is what the appropriate amount of coverage should be for each person they are seeking to cover. Looking at it another way, what will the liquidity need be? That calculation should include direct costs such as the cost of finding, hiring and training a replacement, as well as the indirect cost associated with potential lost revenue from the loss.
Now the company must start to think about the policy type that is most appropriate. Companies may opt for term life insurance, which provides coverage for a specified period, or permanent life insurance, which provides lifetime coverage. For a deeper dive into the differences between term and permanent life insurance, you can see our blog on the topic here.
Of course, when obtaining the policy, no matter the coverage amounts and policy type, it is important that the company be named the owner and beneficiary of the policy.
At C3 Financial Partners, we work with business owners and their advisors to structure and implement key person policies that are tailored to meet the unique needs and requirements of that business.
Coordination
Key person insurance is more than just a financial product – it is a strategic tool that ensures business longevity and stability in the face of unforeseen circumstances. In the simplest form, it provides liquidity to support and sustain operations at what can be a challenging time for a company. This allows for a company to weather the turbulence and ensure its long-term health and success.
At C3 Financial Partners, we look forward to helping our clients gain clarity in their goals and objectives, confidence that they are making the right decisions, and coordinating with their other advisors.
Securities offered through Valmark Securities, Inc. member FINRA, SIPC. Investment advisory products and services offered through Valmark Advisers, Inc., an SEC Registered Investment Advisor. Representatives may transact business, which includes offering products and services and/or responding to inquiries, only in state(s) in which they are properly registered and/or licensed. C3 Financial Partners is a separate entity from Valmark Securities, Inc. and Valmark Advisers, Inc.
