Could your business survive losing its most valuable person?

At a glance

• The key people in your business are those who you rely on heavily for the company to function successfully. It may be a director or an employee with niche expertise or talent.
• Key person insurance can help keep your business afloat in the event that a key person in your company falls seriously ill or dies.
• Shareholder protection insurance allows existing shareholders to retain their equity stake in the company if a key person – such as the founder or chief executive – passes away. 

Does your business rely on the talent or expertise of a key individual? If so, how would it fare if they were no longer able to work?

Small to medium businesses in the UK are notoriously underinsured, leaving them exposed to serious risks. For many, the loss of a key person may result in a major risk. However, putting protection in place to cover this risk can help shield your business from financial vulnerability in the event that one of your key people falls seriously ill or dies.

Who are your key people?

The key people in your business aren’t necessarily those at the top. They could be a director or key decision maker. But they could also be an employee with niche expertise or talent that your business depends heavily on to operate successfully.

For example, even the biggest rock bands would have to cancel their tour if the lead singer could not perform. But the show would probably go on if they had to replace their drummer for a while.

Aside from the chief executive, one way to identify who the key people are in your business may be to consider the following questions:

• Can the business continue to produce its products or deliver its service without this person?
• How long would it take to replace them, and would it be costly to do so?
• Would I need to notify customers or clients if this person were to fall seriously ill or die?

Niki Patel, Tax and Trusts Specialist at SJP says “Failure to insure a key person can lead to loss of profits for the business, disrupt client relationships and could even mean the business has to shut down entirely.”

Protecting the bottom line  

Key person insurance can strengthen your business continuity by providing a cash buffer during uncertain times. Specifically, if a key person in your business takes time out of work due to a serious health problem or dies.

When you make a claim, the insurer will pay your business a cash lump sum which can be used to help keep the business afloat while you work out the next steps. For example, to cover the costs of hiring a replacement, keep up loan repayments and/or substitute revenue in the short-term, if the loss puts your business operations on hold.

The cost of key person insurance depends on several factors relating to the person being insured, such as their age, health factors, and role in the business. This is where getting advice can add value, to ensure you get appropriate cover for a good price.

Safeguarding shareholders

Shareholder protection insurance allows businesses – or shareholders themselves – to insure each shareholder. If a major shareholder passes away, the remaining shareholders can use the insurance payout to buy the deceased’s equity stake.

This ensures that existing shareholders maintain control of the business and prevents them from having to use their own money to maintain their ownership stake. It also prevents company shares being inherited by people not currently involved in the business.

Tax treatment can vary

The tax rules of insurance and protection policies can be complex and depend on how the insurance policies have been implemented.

Key person insurance premiums are generally categorised as a business expense, which means they are exempt from corporate tax. The same applies for shareholder protection insurance, provided the business is paying for the policies rather than the shareholders.

However, tax treatment on claims can differ. Key person insurance payouts are typically categorised as business revenue and are therefore, taxable – but not always.

Shareholder protection insurance claims are typically tax free, but the exact tax treatment will depend on how the insurance policy is structured.  

Choosing what is most suitable for your business

Identifying what type of cover works best for your needs will depend on your business – its size, legal structure, and which employees should be protected. A financial adviser can help you consider the most appropriate option.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.