"Would your business survive if it loses a key person?" is a challenging but crucial question to ask. Unfortunately, most businesses overlook this aspect when setting up their company.

When you lose a key employee – especially someone your business heavily depends on – you may be at risk of destabilisation and face the loss of revenue and the relationships your employee has built with valuable clients. Additionally, hiring a temporary or new high-skilled worker to replace your business' key person will cost you time and money.

Fortunately, if your business does lose an integral employee unexpectedly, key person insurance can help your company move forward and ensure your business is stable. Read on to find out if your business can survive the loss of a key person and, if not, how key person insurance can get your business back on track.

Who is a key person?

You can easily identify your business' key person by determining whose sudden and unexpected absence would significantly impact your company's overall profitability. A key person does not necessarily need to be a company's founder or partner – they could be highly skilled and specialised employees crucial to their department.

Their core skills, expertise, and knowledge are critical to the day-to-day operation of your business. If they are loan guarantors, this may also disrupt funding arrangements with banks or lending firms, thus affecting your company's revenue.

The need to quickly replace the key person to prevent further loss is crucial. However, the cost of hiring and training a new or temporary high-skilled agency staff will not be cheap and will also cost you time. Hence, having key person insurance in place will help mitigate your business' potential loss.

What is key person insurance?

Key person insurance is a type of insurance taken out by the company on the lives of their integral employee while setting the business as the beneficiary of the policy. The insurance aims to protect businesses on the occasion when a key person is unable to work or unexpectedly passes away – it ensures that your company can continue to carry on and thrive in the future.

The company pays the premiums, and in the event of a claim, the business will receive proceeds from the insurance to keep the company from suffering a significant loss. Simply put, key person insurance is life and disability insurance for the key people in a business.

Key person insurance policies typically cover critical illness or trauma, permanent and total disability and death. Based on the requirements and needs of a company, some policies may also offer income protection cover. It is often paid out as a lump sum, so the funds may be used to offset expenses associated with losing a key person, such as training or recruitment costs.

Ultimately, your business can use key person insurance payments to cover expenses, pay off debts, distribute money to stakeholders, pay severance to staff, or close down in an orderly manner. This type of insurance also provides options to shut down systematically while protecting your business' shareholder value rather than declaring immediate bankruptcy for your business in the absence of your integral employee.

What if your business partner is the key person?

More often than not – especially in an SME – your business partners may be your company's key person. In such circumstances, you need to consider the finances involved in buying your partner's shares from their family. However, it is usually challenging to try and negotiate a deal with your partner's family during an emotionally trying time.

With buy-sell agreement insurance, you can avoid that conflict and confrontation. Similar to key person insurance, this agreement is legally binding and specifies what will happen to each stakeholder's shares in their absence. It is divided into two parts:

• The Disposal Mechanism – also known as a Business Will – outlines the consequences of your business partner's absence. It usually includes a valuation method.

• The Funding Mechanism – which funds the buy-sell agreement insurance – has the details of each partner's key person insurance coverage.

Does your business need key person insurance?

If you run a business independently, you will not need key person insurance – though you should consider other forms of life insurance to protect your assets. However, if that is not the case, it is essential for your business to have key person insurance, especially if you run a small and medium-sized enterprise (SME).

Smaller companies tend to rely heavily on their limited employees. Thus, losing an integral person in the organisation could severely impact the business – even resulting in a complete halt. Therefore, if you think your business may be in a tight position if your key employee leaves, getting key person insurance will give you the financial support you need while you get back on your feet.

Although the effects may not be as debilitating, larger companies can also use key person insurance to inject funds into their business in the absence of their integral employee to cover potential lost income, loss of key clients or contracts, and costs of replacing this uniquely skilled person.

How do you arrange for key person insurance?

Once you have determined if your business can withstand the loss of a key person – be it a regular employee or business partner – you should discuss it with your business advisor and then get in touch with an insurance broker. Consulting a professional ensures you get the necessary coverage without paying for unnecessary things.

All businesses depend on their people – however, as mentioned, there are usually a few that may be uniquely valuable, and their loss will impact the company financially. Similar to taking out cover to protect equipment, machinery, and other physical assets, insuring your human assets is equally vital to your business’ success and longevity. With key person insurance, you can ensure your business is financially supported and guaranteed business continuity when the unexpected occurs.

This information is merely general advice and does not take account of your circumstances or needs. It is essential to seek guidance from an experienced insurance broker before you get either key person insurance or buy-sell agreement insurance. Reduce your risk and protect your business today!