There are a number of things in business that we can predict, or at least make an educated guess about. Things like rising costs of gas and electric in the winter, a downturn of sales on out of season products and predictable staff absences with the changing of the seasons. And when you can predict, you can mitigate, but not everything in business is as easy to anticipate.
Imagine you lost a key worker, with no notice and no time to do anything about it. One day you said ‘cheerio’ at the end of your working day; the next, they were just gone. Imagine that the person was not just a good member of your team, but an absolute lynch pin of the business overall. How would you cope with their absence? How would it impact the business? What would be the outcome?
Key person insurance is a policy that protects your business against such unthinkable circumstances. It mitigates for the financial loss you are likely to suffer if a key person involved with the business suddenly dies, is critically injured or terminally ill. You might wonder whether key person insurance is really worth the investment though… I mean, how bad could the loss of a crucial business partner really be…?
Here are two worst case scenerios* that highlight the impact of losing a key person to the business can be, and their happy endings…
Case Study 1: Expert Networks
‘Expert Networks’ had enjoyed a great working relationship with their Technical Director, Tony Paulton, For almost ten years. Tony joined them from a national communications company, bringing with him a wealth of industry expertise and a healthy network of contacts, which he continued to build up over his nine years with the company.
In year nine of his service, Tony’s salary was £145,000 per annum plus up to 50 per cent bonus depending on targets being met. Just two months before his ten-year anniversary, Tony was diagnosed with an aggressive form of pancreatic cancer and sadly died a short while later.
Despite the company being in a healthy trading position at the point of his death, the loss of Tony’s expertise, reputation and contacts was a heavy blow to Expert Networks. Their profits fell by an estimated 20 per cent for the financial year in which he passed away, and dividends to shareholders was significantly reduced.
Had They Had Key Person Insurance
Three years ago, Expert Networks invested in a key person insurance policy for Tony, which was worth a maximum of five times his salary plus bonuses. This meant the company was awarded just over £1m following his death, giving them the money to absorb the losses in profits without slowing down business, to appease their shareholders and to recruit a suitable replacement in good time.
Case Study 2: Clever Legal Services
Tom Watson and James Bailey set up ‘Clever Legal Services’ around six years ago, when Tom decided to make a break from his old firm and set up on his own. Tom is 57 and a highly experienced lawyer. James is 36 and provides all the support Tom needs in administration, staffing and marketing the business. Together they make an excellent team, and their legal service is now worth over £750,000.
Sadly, Tom suffers a stroke and cannot work in the business any longer. Many months pass by and the business begins to start showing cracks. James cannot hire in a new business partner, as Tom is still taking his salary from the company. He would like to buy out Tom, but the pair cannot decide on a fair valuation. Sometime later, Tom dies, leaving his assets including his interest in the business to his wife, Carol.
Poor James is left to pick up the pieces. He now has no money to replace the loss of Tom’s knowledge to the business, and is left with a business partner (Carol) who cannot help him run the company. Worse than that, the loan that the business took out to purchase new premises was guaranteed by both Tom and James together, and Tom’s death has triggered an automatic default. The lender is now demanding that James either renegotiate the loan at a higher interest rate, or pay it all back right away.
Had They Had Key Person Insurance
When Tom suffered a stroke, James was able to claim a partial payment of the key person insurance that the company had taken out on Tom. This was enough to cover the cost of recruitment and salary for a new expert lawyer while still paying Tom, as well as to pay off the big loan that the company had previously taken out. When Tom passed away, James was able to make Carol a healthy offer for her share of the business, leaving him the sole partner in a thriving business, who eventually sold the company for over £1m and took retirement at age 49.
Although thinking about the worst probably doesn’t appeal, sometimes putting reality into perspective can help to weigh up the pros and cons of the decision. Not every business will run into dire trouble if a certain person dies, but for those businesses who really do rely on the knowledge, expertise or reputation of one or two ‘superstars’, this type of insurance really is a must-have.
If you would like to discuss any of the above in more depth, please contact me. Call me on 01252 757 277 or fill in this contact form and I’ll call you.
* the company names and individuals in the above case studies have been changed to protect their identities.