Key Person GONE! Is your business protected?

“Risk is caused by people” Robert Lehman

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Risk identification and management have always been vital elements of our Firm’s business. Whether entering new markets, advising clients on financings, or mergers/acquisitions, buying a business, or seeking to protect one’s family, partners, or employees, risk management strategies were ever-present and various insurance tools have been utilized to mitigate those risks. In the next few posts, we will look at various risk mitigation tools businesses can utilize in their domestic and international operations.

With the global spread of the Covid pandemic claiming lives of millions of people, the risks have increased significantly and forced us to take a much deeper look at the potential problems and ways to mitigate them. In this article, I want to focus on a very important, but frequently overlooked risk of losing a key person and explore how a business based in the US, or one entering the US market, can protect itself.

Every business, whether it is a sole proprietorship, partnership, or corporation has folks vital to the ongoing success of that enterprise. Loss of these key people to death, or disability, whether it is CEO, CFO, Head of Sales, Chief Scientist, will have a crippling and costly effect.

So how do key business stakeholders protect themselves? Couple of obvious, but highly underused tools are Key Person Insurance and insurance funded buy-sell agreements.

Key person life and disability policies are meant to compensate the business for losses incurred by a loss of its vital personnel, or shareholders. Such policy premiums are paid by the business and the business will receive any insurance payouts to help cushion the impact of losses. Normally, key person life insurance is structured as a fixed premium 10 or 20 year term policy and the benefit amount of the policy is calculated to compensate for the value of the expected loss. For instance, if a company has a key Sales Manager, who produces $2 million per year in revenue and it is expected that it would take 6 months to a year to replace such a person, a $1 to 2 million term life should be taken out. The investment in such a term policy is negligible compared to the benefits business will receive should a catastrophic loss occur.

Another very interesting situation occurs in closely held corporations, partnerships or sole proprietorships. If an owner, partner, or a significant shareholder succumbs, or becomes disabled, their ownership interests oftentimes pass to the family members, who oftentimes are unwilling, or unqualified to continue running the business, or perform shareholders duties. In such cases, buy-sell agreements should be funded by term insurance policies large enough to cover the fair market value of the ownership interests. In case of a loss of a sole proprietor, the owners family should carry the life insurance/disability insurance to compensate it for the loss of the bread winner. Alternatively, business managers may use a business Key Person policy to buyout the owner’s family and take over the business.

Thus in today’s business climate, any entity not managing its key person risks is remiss and is putting its own survival at risk. To learn more about key person risk mitigation, or to discuss other types of risk management, please email info@broadstreetcap.com