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Picture this scenario....a key partner in a small engineering firm dies suddenly in an accident. In one scenario, faced with the immediate loss of revenue, the firm struggles to pay salaries, overhead and day-to-day expenses. Efforts to borrow money from the bank are difficult due to the uncertain future of the company and the grieving spouse experiences a Financial nightmare. Eventually the practice is closed and the value of the deceased partner's share of the business evaporates as the remaining partners do not have the capital to buy out the spouse's interest. In the second scenario, cash is injected into the company, the practice transitions smoothly within the firm, and the spouse is paid generously for their shares.

So how did the firm in the second scenario manage to stay financial healthy after one of its senior partners was gone? All the partners at this firm had purchased Key Person life, disability, and critical illness insurance policies to insure two year's profits in the event that any of the partners became critically ill, disabled or dead.

The best way to protect your firm from financial hardships and to meet its financial obligations is through proper planning with the right professionals. Having Key Person Insurance (sometime referred to as Key Man Insurance) in place, will ensure your firm's survival and help each partner meet his or her financial and estate planning needs.

It is unfortunate that Key Person coverage is not part of all company's long term business planning. Often the focus is on growing profits and market share, while scant attention is paid to protecting the value that has already be created. Many businesses have been built around the strengths and skills of a few individuals whose capital, energy, knowledge, or experience makes them a valuable asset to the organization.

Key Person Insurance can help preserve the value of your business and its continuation in the event of the death of a key stakeholder. Replacing the expertise and knowledge of an essential individual can take time and money. Key Person Insurance protects a firm against various financial setbacks that can result from an accident, a sickness or death of an integral member of the practice. This key person could be you or anyone else critical to the firm's continued operation and success. Key person coverage provides liquidity to replace lost revenue due to the death of that essential person, the repayment of business loans, and buys the company time to recruit and train a suitable replacement. At a time of uncertainty, tax-free cash is injected into the business to ensure its survival and reassure creditors that company is on solid footing.

Lenders hate uncertainty and the loss of a key person from a business either short term or permanently will make them nervous; making accessing new money after the death of a key member of the team difficult. Key Person Insurance can also improve your firm's chances for loan approval while everyone is healthy as lenders look favourably on a firm with the proper insurance in place since it shows responsible planning and makes it more likely creditors will be repaid. In fact, Key Person Insurance is often now becoming a requirement of lenders as well as investors to secure such funds.

If a firm has partners, a properly funded buy-sell agreement is critical. Insurance is the most cost effective way to ensure there are funds available at this critical time and will facilitate the remaining partner(s) to purchase the business interest of the deceased or permanently disabled owner.

So how much Key Person coverage is the right amount? That depends on the impact that the key person's death would have on the company. Although it serves a need in any size corporation, it is most critical for small and medium size businesses. This is because the success of this size company often hinges solely on the skills and experience of a select handful of individuals. Should one of these key employees or executives experience death or disability, the company may find it difficult to continue. Although it may be complicated to determine the exact amount, you must consider the person's financial contribution to the company, their industry knowledge or goodwill generated by the person, the cost of hiring and training a replacement, and the firm's outstanding debt. There are rules of thumb such as five to ten times the key person's salary or two year's net earnings of the company. If the insurance is also being used to fund a buy-sell agreement, the value of the business both now and potentially in the future must be considered. Working with a professional who specializes in helping business owners will make the process easier.

Risk management is a key component of business planning and prudent companies plan for the unexpected. Don't let an emotional nightmare turn into a financial one as well.