Are You Risking Too Much?
Most business owners are risk takers by nature. Running a business is not for the
faint of heart or weak of stomach. But, most who take the self-employment plunge like
living on the edge---the stakes can be high, but the rewards are worth the risk. Even so,
most prudent business people seek ways to offset the risk, to minimize the impact of
adversity.
Very few savvy owners would dream of operating without the safety net of property/casualty
insurance. In fact, most would have a difficult time getting credit without proof of this
coverage---without evidence that the property and capital assets of the business are
protected in the event of an accident or a disaster. That makes good sense. Capital assets
are a tremendous investment, and with the exception of more service-oriented businesses,
typically account for a big share of a business' value.
What doesn't make sense is that most business people fail to insure their most critical
assets. All the buildings, equipment, and property in the world won't turn a profit by
themselves: the key to a prosperous enterprise is always the people involved in bringing
the machinery to life. Successful owners have a real sense of urgency with respect to
their employee benefit packages. They know attracting and keeping the best employees
starts with a secure and competitive program. They reward their key executives with
selective benefits. Yet, these owners who recognize the critical role their employees
play, and are concerned with keeping them (in essence protecting the business from the
loss of an employee to a competitor) fail to protect the business from the unexpected
death of key employee. It can happen in an instant. And the bottom line will be
impacted. You can bet on that.
Knowing the value of your key employees is your first move to minimizing this risk. There
are a variety of ways to estimate the value of an employee to your business. One common
way is to estimate the employee's contribution to profits. Another is to estimate the cost
of replacing the employee, and yet another is to multiply the annual salary by a number of
years ( five years is a rule of thumb). Finally, you can average the result of all three
of these methods. Clearly, the valuation isn't all that scientific...and it's not even the
most important issue. Rather, the most critical issue is ensuring the dollars are there
for the business if, for example, your top salesperson---or one of the
shareholders---dies. Here are some methods to consider:
Build a sinking fund. Make regular deposits into an interest-bearing vehicle to build a fund from which the business can draw to offset the cost of lost revenue, hiring, and training. This may work nicely, except that time may not be on your side. A sinking fund doesn't help if tragedy strikes tomorrow.
Borrow the money. This strategy is viable, but consider the cost of the credit, if it's available. Also, consider the Catch-22---will a lender be amenable to extending credit to cover the loss when the business may be in a compromised revenue position without the employee, especially if that employee is also an owner?
Self-insure. Absorbing the loss of the employee's services and picking up the extra work yourself, or spreading it over other employees can work in the short run. Long term, you may be headed for a burnout situation. This strategy isn't really managing the risk and preparing the business for the financial impact.
Key person insurance. Purchasing business-owned key person life insurance is a widely-recognized method of deflecting the risk of an untimely loss. While the premiums for this life insurance aren't a deductible business expense, the death benefits are payable to the company, and are income tax-free. The benefit, which is tied to the value you've placed on your employee's impact to the bottom line, can be used to buy time, and more importantly, peace of mind. Insurance companies can issue a policy on the life of each of the employees you can't afford to lose. Some companies also offer an affordable alternative with first-to-die policies, which cover several lives under one policy, paying a benefit at the first death only. Insuring this risk makes sense:
 | Unlike the sinking fund, the insurance benefit will be there when you most need it, as long as the policy premiums are paid. |
| As for creditors, instead of having to ask for money, you may be able to enhance your position by showing you have plans for handling adverse situations. |
| Instead of self-insuring, where your business continues to bear the full brunt of the risk, shift that risk to the insurance company. |
Being in business is indeed being at risk. Managing the impact of potential adversity is a sound strategy, and important for the long-term. You wouldn't dream of operating without insurance on your hard property and equipment. Operating without insurance on your most valuable human assets could be exposing you and your business to an uncertain future---are you risking too much?
