“Would you like to buy some insurance?” No one likes an insurance salesman… except maybe an insurance salesman. Despite that, we often need insurance and are usually underserved with insurance we buy ourselves. Making yourself informed about the types of business and life insurance available to you as an entrepreneur is one of the soundest decisions you will make. To that end, I want to share some advice I recently received on the true benefit of getting the right insurance.
Perhaps an obvious admission, terms matter in insurance — and in business, it’s perhaps even more important. Did you know you can use certain key man provisions in insurance to help your best and brightest buy you out? No? What about utilizing specific clauses to ensure your spouse will never have to deal with the business should you die before your successor takes over and yet will also receive good compensation from your death benefit? And what if you own a farm that your children are involved in at various levels — how do you insure that the kid who really wants to run the business and has helped you grow it over the years is going to inherit it, and that your other kids still get a nice chunk of cash when you pass so you don’t have to worry about them fighting over the farm and possibly breaking it up?
All of this is to say it comes back to that word: insure. You need to insure your business’ future as an ongoing concern and to protect your legacy. When thinking about insurance for your business, the terms are what will drive the actual dollars that get divvied up, to whom and from where.
If an owner suddenly dies or becomes unable to perform the duties of their role and there’s no funding to complete the buy-sell agreement, you can quickly tank a business. Between clients jumping ship from a perceived weakness to having to train and develop a new CEO, there’s a lot at risk if you don’t have the cash to cover such an event. And, depending on the special skills of that individual, you may be looking at two to three times that person’s salary before this is done.
Don’t worry! Key man insurance can help you with these unexpected and unwelcome situations.
Key Man Insurance
One of the more popular types of business insurance is the key man insurance. You’ve likely heard of it; if you haven’t, listen up. One of the best things you can do today is ask yourself who is absolutely integral to your business. Who is indispensable? Whose loss would lower the value of your business to an outside buyer?
Nine out of ten times, you’re going to say someone like your accountant who has been with your company for 20-odd years. (Hint: If you said yourself, you’re wrong.) So what can you do to keep this person around should some major changes happen?
Insurance, literally, is a guarantee of protection or safety. You want to insure this person (and assure them) their job is still there, their still needed and you will do what you can to make them happy. Stay bonuses are one thing that helps with this. Another is insuring them and their role so that if you lost them for whatever reason, your business wouldn’t be crippled.
Look at it from a value standpoint. If you take that individual’s salary and then add in all the training time, natural inclination at the role and the time it would take to replace them (both in hunting for the right person and also new training time), you can admit that his or her loss would be substantial. And it would be quite costly to replace him or her.
You’ll want to insure that role or person so that if the unthinkable happens you have the funds available (not out of working capital or cash) to fill their over-sized shoes. It is a huge relief to not have to fight or scrounge for funds when a crisis occurs, so don’t undervalue the role of key man insurance.
You can even fund a buyout via key man insurance. Depending on how you structure it, you can get the insurance company to fund a purchase event from an owner who is unable to return to duties. You’ll need to consider who you want to take over, but if the cash isn’t readily available in your business, the insurance can bridge that gap.
We’ll touch on this briefly, since most of you are familiar with stay bonuses and a few of you have likely been subject to one yourself. Essentially, you want to keep an employee through any transition that may happen, so you offer him or her a chunk of money to stick around and help carry the business forward. This is used both when an external buyer comes in and the employee’s value is such that the new employer would have less risk if this employee stayed around as well as when doing an internal transition and there’s a period of the unknown as fresh hands take the reins.
No matter what the situation is, you want to make sure the stay bonus is large enough that those head hunting companies out there (aka, your competitors) would have to pay through the nose to take this valuable employee. What does it take? A good suggestion is to take a look at that employee’s salary over the next six to seven years and make that the bonus if the individual stays on to the completion of the terms of their agreement.
So, yes, terms matter. But I digress…
What if the owner isn’t ready to return after a year? Many clauses effectively push an individual out after a year, whether they want to come back or not. You need to make sure the terms are agreeable to you and are updated regularly — ideally yearly. Major events in your health or your business’ can derail your long-term plans or at least alter them. You need to know your options and what you want out of the situation.
There is insurance for almost any situation you can think up, and you can count on insurance companies creating new policies and plans to cover those unique situations they have not yet accounted for. The thing to remember is insurance can save your company if you know yourself and your company well enough to adequately cover the details.
So ask yourself: who is irreplaceable? What would it actually cost to replace that person if it came down to it? What do you want to happen if you became unable to work? If you have an advisor you can trust to talk to about this, or you know someone you can have a frank discussion with who is an insurance broker, do yourself a favor and book some time asap.