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This is a weekly look at Wyoming business questions from the Wyoming Small Business Development Center (WSBDC), part of WyomingEntrepreneur.Biz, a collection of business assistance programs at the University of Wyoming.
By Leonard Holler, WyomingEntrepreneur WSBDC regional director
"Why would I need ‘key man insurance' for my business?" Walt, Casper
After reading a recent article, "Have You Insured Your Company's Most Valuable Resource?", by Dana Sydney of Dayton & Sydney, LLC, an insurance adviser, I would say there are several good reasons for the company to carry insurance on your key employees and yourself.
Insuring a key person can spell the difference between the failure and survival of a business.
Here are some of the benefits of providing life insurance on the unexpected loss of a key person in a company and a few things to keep in mind when purchasing "key person insurance." The insurance can help a company survive the operational loss and financial strain that follows the death of a key employee or owner.
-- Business loans or investments can be repaid. When a key person dies, especially an owner, a lender may have the right to call on existing loans. Life insurance proceeds can help pay off those loans or fund a buy/sell agreement.
-- Credit can be maintained. At the death of a key person, lenders may become reluctant to lend new money to the business or refinance existing debts. Life insurance can help pay its bills from vendors in a timely manner in spite of death.
-- A suitable replacement can be recruited and trained. It may take months before a qualified candidate is found and time to train them to the point where they are as competent as their predecessor. Insurance proceeds buy time for the business to regroup.
-- The business is sheltered from lost sales and profits. Insurance could help offset dips in revenue that will probably occur, at least temporarily, when a key person dies.
-- Stock can be repurchased. If the business is a corporation, common stock owned by the descendant's heirs can be repurchased by the company with the insurance proceeds. This enables a surviving owner to buy out a deceased owner's share of the company.
Key person life insurance policy is owned by the business, pays the premiums and is the beneficiary. The premiums vary based on the age, physical condition and health history of the insured. The need for key person insurance depends on a company's structure, its continuation plans and the amount of financial hardship without that key person. Not all businesses need key person insurance.
In large companies, there may be less likelihood that a single individual is indispensable to a company's continued success. In one-person firms, the business is not likely to survive without the principal no matter how much money is available.
There are several valuation techniques that can be used to determine how much key person insurance is appropriate. No one method is best. Buying key person life insurance can be a relatively small expense and, hopefully, you never have to collect on it.
But failure to invest in a key person policy and then have that person die can be an enormous expense. Your company may be able to absorb small expenses, but what about those bigger expenses created by the loss of a key person in the company?
A blog version of this article and an opportunity to post comments is available at http://www.wyomingentrepreneur.typepad.com/blog/.
The WSBDC is a partnership of the U.S. Small Business Administration, the Wyoming Business Council and the University of Wyoming. To ask a question, call 1-800-348-5194, email email@example.com or write 1000 E. University Ave., Dept. 3922, Laramie, WY, 82071-3922.