When you own a business, you like to think that you’re in control, especially of the things that most affect its value. Fortunately, you do have control over several of them, such as:
Access to Capital – Accessing and gaining the necessary capital to improve or expand your operation when needed.
Customer Base – Building a solid and diversified customer base over time.
Economies of Scale – Creating buying power for your growing business.
If you control and manage the above, you are increasing your business wealth. However, there is one important aspect that you have no control over that can negatively impact your company’s value, and that is your team.
Human Capital is a company’s key value component which is made up of employees’ knowledge base, skills, and experience.
Have you ever considered what would happen to your revenue stream, and ultimately the value of your business, if the unimaginable happened to a key employee? What if your most profitable sales associate died in a tragic accident? What if your executive vice president, who’s the backbone of your business, became disabled?
While these scenarios are rare, they do happen. It is important to plan accordingly to make sure that your business has the financial capacity to continue operating in the event that the unimaginable happens to an employee you can’t imagine being without.
Business owners commonly use two tactics to prevent the dissolution of a business should a key person pass away or become incapacitated.
- Simple Key Man Life Insurance Policy – This works exactly like it sounds. You purchase life insurance on your key employee(s) and list your company as the recipient of the death benefits should the employee pass away. For example, if your star salesperson passes, the death benefit will be paid to your company to make up for lost revenue he or she would have brought in, which gives your organization time to find and hire a salesperson who can replace the employee who is not longer with you. The death proceeds also can be to attract, recruit, hire and train a new salesperson with a signing bonus and possibly increased compensation for the first few years.
- Highly Compensated Employee Deferred Compensation – two birds….one stone. This strategy is a case of “two birds, one stone,” but is a bit more complex. It can act as a “golden handcuff,” as well as protect the business in the event your key person passes away.
When you fund a deferred compensation plan with a cash value life insurance policy, you are naming the company as the beneficiary of the policy in the event that the employee passes and you can allow the employee to own the “cash value” of the policy at some point in the future based upon the restrictions that you choose to put in the plan.
Here’s an example of how it works:
Sally is your best sales representative. You write a cash value life insurance policy on Sally’s life for $1,000,000, and you put $15,000 per year into the policy to pay for the death benefit and build cash value.
If Sally unexpectedly passes away, the company receives a $1,000,000 death benefit that will help offset the loss of revenue and be spent to attract a new employee to replace Sally, much like how the Key Man Life Insurance policy. In addition, it is estimated that the cash value will be worth $300,000 at Sally’s full retirement age. If Sally is still with the company at full retirement age, she is entitled to receive the cash value as a deferred compensation payment, which will act as an incentive for Sally to continue to work for your organization.
These two tactics can be very effective in protecting the value that human capital adds to your business. However, these are just two of many tactics that are options for business owners. It’s possible to become very creative with these plans to better protect your business, while creating added incentives for your employees to continue the great work that they do.
I would highly recommend consulting a CFP® professional or wealth advisor to help you develop the best plan incorporating these and/or other strategies for your business. At Metcalf Partners Wealth Management in Overland Park, Kansas, we have many years of experience helping business owners, like you, find ways to increase and protect the value of their business wealth.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. We suggest that you speak with a tax professional about your individual situation before taking any actions.