How to protect your business against the loss of key personnel

Business owners can’t always accurately predict the future, but they can mitigate the common risk of an important individual being unexpectedly absent. Simon Stygall, Chartered Financial Planner at Close Brothers Asset Management, explains how.

It is often said that people are the biggest asset of a business. By the same token, the greatest risk facing most businesses is therefore the loss of key people. There can be far-reaching operational and financial implications for a business if its owner, co-owner, or a key employee, should fall seriously ill, or sadly even die.

The challenges that could arise include:

• The business struggling to function as normal, or not even functioning at all, leading to a fall in revenues and profits. As a consequence, the owner of the business, their family members and other employees could all face reduced living standards.
• Difficulty in meeting costs and repaying debts, including any outstanding debts owed to a deceased or seriously ill owner.
• Customers, lenders and suppliers losing confidence in the business’s ability to deliver on its obligations.
• Increased costs, especially if the business needs to recruit a replacement for the owner or key employee who is no longer available.
  
  

Business protection

While the risks of losing an owner or key worker are considerable, they can be mitigated through the use of some effective business protection strategies:

1. Business continuation insurance helps to protect a business against financial losses in the event that an owner or key individual falls critically ill and dies. It provides funding to compensate for any shortfall in profits and cover loan repayments.
   
   
2. Key person insurance provides a valuable cash injection into the business, enabling it to survive while it finds a way to cover the key person who has become unavailable. This person could be the owner, a top sales manager or someone in an integral support role, such as the finance director.
   
   
3. Income protection insurance provides income to key people – both owners and employees – if they are unable to work due to illness or injury.
   
   
4. Family protection insurance is a kind of life insurance that pays out either a lump sum or income on the death of a key individual. Premiums can be paid by the business and the benefit would be paid under a trust, free of inheritance tax, to the family of the key individual.
   
   
5. Life insurance pays out a lump sum on the policyholder’s death. It is particularly important for sole traders since there is no business without them. If they were to die, their family could potentially face serious financial consequences. The use of a trust protects against the pay-out from the policy being subject to inheritance tax.
   
   

Succession strategies

Succession strategies also play an important role in protecting businesses from the risks that can arise when a key individual is absent:

• A succession plan helps to ensure business continuity by setting out the long-term plan for the business. Succession plans can be used to cover both exit (when a business owner plans to leave or retire) and emergencies (when an owner is suddenly unavailable to work within the business, because of death or illness).
• Shareholder protection insurance, used in conjunction with a cross option agreement, enables continuing owners to buy a deceased co-owner’s share of the business. The surviving shareholders receive a lump sum that allows them to purchase the shares from the beneficiaries of the deceased co-owner. As a result, the continuing owners secure ownership of the business, while the owner’s family members benefit from the cash proceeds of the sale. This arrangement maintains business relief from the inheritance tax when the proceeds of the sale of the shares are included in the estate.

Understandably, the unexpected loss of key personnel – including themselves – is something no business owner wants to think about. Nevertheless, it is a common business risk that they should consider and plan for – so far as they are able to. As the COVID-19 pandemic has highlighted, tragic events can occur suddenly.

Business owners can begin the planning process by envisaging what ‘business life’ would look like if either they, their co-owner, or another key employee, was suddenly absent from the business. How would both the individuals concerned and their family members be affected?

By talking to their financial advisers, they can also gain an understanding of the financial, legal and tax implications of the different protection strategies available – as well as the likely consequences of having no or inadequate plans in place. Protection doesn’t have to be a gloomy subject – it’s just about sensibly preparing for the worst while keeping a positive perspective on the future and firmly hoping for the best. 

To find out more about how we can support you with protecting your business against key person risks, please call 0800 345 7078 or email contactus@closebrothers.com

Capital at risk. Any tax benefits depend on individual circumstances and tax rules are subject to change.

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