If your business is like millions of other small or medium businesses in Australia, it’s likely that you’ll have one or more individuals whose involvement is critical to its success.
This ‘key person’ might be important because of their investment or experience, their technical expertise or their business connections. And while we don’t like to think about it, no longer having this key person involved could put undue pressure on you and the business, affecting your health and wellbeing, and potentially the long term financial viability of the business.
But there’s a few ways business owners can minimise the impact of this risk, and using a mix of options is usually the best approach.
Who is a key person?
A key person is anyone whose continued association with your business provides a significant economic gain. This can mean any of the following:
- increased sales and revenue
- cost savings
- increased profit
- increased goodwill
- ability to access finance, and
- ability to access or retain customers.
A key person can include employees, owners of the business, managing directors, even suppliers— generally those persons whose loss would have a significant impact on the financial viability of the business. A non-working shareholder, such as a silent partner, who puts up their personal assets as security for business loans may also be a key person if the business relies on these guarantees.
Like most risks, planning ahead can significantly impact how well you deal with the risk if it does occur.
Business owners can address key person risk in a number of ways. For example, owners might have a succession plan in place where the next generation of leadership is being primed, or a staff training program where knowledge is regularly shared and documented.
Or, they may have alternative investment options in mind, and a business which relies on key supplier relationships may have already investigated alternatives should something happen in the supply chain. Whether formal or informal – business planning is always a good idea.
Adding insurance to the mix is a financial option to help businesses through the difficulty of replacing a key person. Most businesses take out insurance cover against damage from fire or public liability or professional indemnity. But for many businesses their most important assets – their key people – are left unprotected.
Should you include insurance?
Key person insurance is usually life, total and permanent disability (TPD) or trauma cover taken out on the life of a key person.
The idea is that a business can use the insurance proceeds to replace lost revenue, repay debt, cover expense items or inject required capital into the business.
As the purpose of insurance is to ensure the ongoing viability of a business, policies taken out to protect the business are typically owned by the business. With premiums typically paid by the business.
Preparing your plan
Your adviser can help you work out a plan that suits your needs with the right mix of options for your business. Key things to consider include:
- which activities and inputs are key to your business and why
- estimating the loss of revenue or profits
- whether any clients would be lost and the impact
- how you would find a suitable replacement and the costs involved, and
- what it will take for the replacement to be fully functioning and the cost.
Including key person considerations in your business planning can help clarify what’s needed to suit your circumstances, giving you peace of mind so you can confidently make your business flourish.