Business Continuity, are you prepared? – Part 1
One of the most commonly questions asked by investors when starting any business is “What is your exit strategy?” A basic theme of business in general is to never start something without knowing exactly what you want to get out of it – and how to get out when you get it. But what if your exit is of the unplanned and unexpected variety, in the form of a sudden short or long term disability? Do you have the right pieces in place to be sure it will be business as usual when you or any other key employee is unable to make it to work for an extended period?
Problem
One mistake people make when growing a small business is putting too much emphasis on the production of one or a handful of employees, thereby leaving the company extremely exposed to large dips in revenue when that employee or those employees are unable to produce. Planning an exit strategy may be common practice but too often it will only include a plan for when it is time to shut down the business because a final goal or conversely a point of no return has been reached. In any business involving more than a sole proprietor there is always a possibility that one person will at some point be unable to work while the other partner(s) wants to continue on with business as usual. Lamenting the productivity loss of a partner can only last for so long before the remaining key components of the business start to look around and wonder if a course of action is in place for how to avoid a major slip in productivity.
Solution
Key man disability insurance is designed to protect a business in the event that a key employee or executive suffers a disabling accident or illness. It provides business owners with the peace of mind to know that the business can continue operations without major disruption in the case of a disability to an executive or key employee. Key man disability insurance is purchased on one or more people in a business that are important to the revenue stream of the company to protect the business from the economic loss associated with a disability. The company buys the insurance and is also the beneficiary of the policy should a disability arise. If disability occurs, benefits will be paid as long as the key employee cannot perform the regular and substantial duties of his traditional occupation. The funds can be used at the company’s discretion to stabilize the company until a replacement employee is located or the disabled employee is fully healed and has returned to work full time.
When considering key person disability insurance, there are some important questions to ask to determine the value to place on an individual. For example, there is the replacement cost method – i.e. how hard will it be and what type of compensation will be required to locate and train a replacement? There is also the contribution to earnings method – i.e. what percentage of revenue can be directly attributable to that key employee and what kind of decrease of that percentage would we see as a direct result of a disability? By asking these questions about all owners and key employees, any business can start to get a pretty solid idea of what kind of coverage levels are needed for each person.
Some very basic disability policies will use the old standby of a multiple of earnings on the current salary of a key employee to find a value that can be placed on the loss of that individual. While this may be a little more rudimentary and the other methods described above would have a bit more of a direct correlation to company earnings, the important thing is not how it is done but that it is done at all. By having the conversation with your business partners about yourselves and other key employees in relation to key man disability insurance and placing a value on each key cog in your business machine, you are providing your business with a more accurate depiction of the potential of an unexpected short or long term exit and putting in place a strategy that may be needed to survive. According to a 2003 study by the American Council of Life Insurers, the likelihood of an employee in a small business (5-100 employees) becoming disabled is 1 in 4. If you’re top salesperson was to end up on the wrong side of that statistic tomorrow, would your business be prepared?
….Stay tuned for more on Business Continuity….
Brian Lynch is a Senior Consultant at HSG Global Services. HSG Global Services provides management consulting and outsourced services to the international business community.
