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What is your most important asset?

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“Take away all my factories and my equipment. Take away my wealth…But leave me with my key people and in a short time I’ll have it all back again.” — Andrew Carnegie

Andrew Carnegie, arguably one of the most successful businessmen and entrepreneurs in American history, felt the key determinant to his success was the people who really made him successful. 

For small-business owners, key employees add a great deal of value to their business. Because the contributions are so essential and irreplaceable, it isn’t surprising business owners find it helpful to spend some time looking at ways to protect this most important asset.

So who are some of the key people in the organization? Many business owners define key people based on:

  • High salary — High value put on employee
  • Decision-making power — Employee controls business direction
  • Frequent direct client contact — The relationships business success depends on make for a substantial power base
  • Crucial position — Employees in product development, production, technology or sales
  • Special talents — Employees who are difficult to replace

And of course, in the vast majority of businesses, the owner who is involved in day-to-day operations may be the most important employee of all.

These are some of the ways these key people add value to the business. Some of them may be more applicable than others, and based on their situation, there certainly may be some not listed here.

What impact would their loss have on the business? The ways in which they add value would be the nature of the loss suffered — lost accounts and sales, lost profits, lost management skill.

What would be the economic impact if key employees were no longer actively involved in the business? How is the business at risk? A key employee could —

  • Leave the business or move to a competitor,
  • Suffer a disability or a critical/chronic illness, or
  • Die.

What would be the economic impact if key employees were no longer actively involved in the business? There are steps small-business owners can take to protect themselves from these risks and minimize the impact. Small-business owners should start by asking themselves:

  • How can I attract and retain key employees?
  • How will my business survive the loss of a key employee?
  • What will happen to my business if I die?
  • What will happen to my business if my partner dies?
  • How do I implement plans that are appropriate for my unique situation?

Strategies for retaining key employees

In a perfect world, how would we go about increasing our retention?

If this problem could be solved simply by increasing pay or offering a larger bonus, we wouldn’t need to publish articles like this. The truth is that bonuses are expected and, once paid, are quickly spent and forgotten. Benefits, on the other hand, can last a lifetime.

Employees that offer unique contributions desire unique rewards. However, individual benefits will have an even greater impact on the high performer. There are strategies that can allow small-business owners to offer a benefit to a specific employee at levels that are completely discretionary and are deductible to the small employer. As an employer, they can pick and choose.

This can be accomplished by using strategies that are not directly regulated by the federal government and fall outside the auspices of ERISA. Unlike IRAs or 401(k) programs, these strategies don’t limit the level of funding. This can be especially important for highly compensated employees.

Because tax-qualified retirement plans place limits on annual contributions, highly compensated employees have difficulty replacing the same percentage of their income than a more modestly compensated employee.

Employee benefit and incentive programs that meet three criteria will effectively attract and retain key talent while minimizing committed resources:


  • Allows an employer to pick and choose participants
  • Offers custom-designed programs


  • Bonuses are spent and forgotten
  • Benefits, on the other hand, can last a lifetime


  • Plans that have very little, if any, administrative cost
  • Qualified plans can cost thousands of dollars and a great deal of time to administer

Two plans may do the best job of meeting these criteria and are easy to implement:

Executive bonus plan

  • Allows the small-business owner to pay an employee a bonus that is used to fund valuable insurance coverage for them and their family and is a tax deduction for the business.
  • Your key employee receives much-needed insurance coverage at little or no cost.
  • Can be used to fund the employee’s personal financial plan.
  • You can pick and choose to whom this benefit would be offered and at what level.
  • No administrative or government reporting costs.

The bonus can be paid into IRAs, annuities, life insurance or taxable investments. Life insurance is the most common funding vehicle because it provides significant tax benefits and death benefit protection.

The employer pays a bonus to the employee. The bonus is deductible to the employer and taxable to the employee. The employee maintains all the rights associated with owning a permanent life insurance policy (death benefit; disability, chronic and critical illness benefits; cash values; and an additional income source upon retirement).

A second option

In some situations, small-business owners might prefer a benefit plan that allows them to exercise greater control over the employee and benefit structure.

Employers can custom-build a plan that specifies a:

  • Vesting schedule
  • Retirement income, with post-retirement disability benefit
  • Disability and critical illness benefits
  • Death benefit

This plan is known as a deferred compensation plan.

How does it work?

Part one: Design the benefit agreement

  • The business and employee arrive at an agreement as to all aspects of the benefit structure.
  • The specifics of the benefit structure are drafted into a binding legal document.
  • The business is responsible for pooling the money necessary to fund the benefits.
  • The business can fund the plan completely.
  • Or the employee can defer pre-tax compensation.

Salary continuation and deferred compensation plans possible negotiation points:

  • Vesting schedule
  • Death benefits
  • Disability benefit
  • Duration of retirement payments

Part two: The funding vehicle and the payment of benefits

  • Products used to fund the plan should match the benefit structure.
  • If insurance is used, benefits will be available to fulfill the business’ obligation to the employee.
  • Insurance benefits are usually received income tax free by the business.
  • The business then disburses the funds to the employee or their beneficiary.
  • These payments are usually tax-deductible by the business.

Indemnifying the business

What if a key employee dies?

  • If you have one key employee in his/her 30s…there is a 24 percent chance he or she will not live to 65.
  • If you have two key employees in their 40s…there is a 30 percent chance one of them will not live to 65.
  • If you have three key employee in their 50s…there is a 45 percent chance one of them will not live to 65.

And according to LIMRA, 70 percent of all businesses that were dependent on a key employee failed with the death of that employee.

Before age 65, the probability of surviving a critical illness is almost twice as great as dying. This means, a small-business owner is more likely to lose a key employee due to disability or a critical illness. What challenges will a small-business face if its owner or a key employee suffer a critical illness and is unable to work?

Today, there are cost-effective ways to protect a business from these events that threaten long-term profitability.

Key employee insurance

If a business owner is unable fulfill his or her management responsibilities, the remaining deceased owner’s family, or partners and shareholders, arrive at a serious crossroads in the life of the business.

At these times, there is a need for both immediate cash and ongoing income. Should the business be kept as an on-going concern? Can it be sold to a willing buyer at a fair market value? Must the assets of the business be liquidated as quickly as possible to provide immediate funds?

Life insurance can provide funds when they are most needed:

  • Immediate cash to fund short-term operating needs
  • Replace family income
  • Meet payroll while executing business exit plan
  • Keep the business profitable while the business is for sale to protect business value

What will happen to the business if the partner dies?

Four transition alternatives:

  1. Heirs can be brought into the business
  2. Accept outside owners into the business
  3. Sell to partner’s heirs
  4. Buy out heirs

Transition goals:

  • Maintain profitability of the business
  • Protect the value of business
  • Minimize interruption in operations
  • Meet short-term financial and production obligations

Transition realities

  • 75% of all businesses fail when a partner dies.

In nearly all cases, buying out the heirs is the best way to protect the value and profitability of the business. Also, it removes the burden of business ownership from the heirs and provides additional liquidity to the estate.

However, it can require the surviving partner to have a great deal of cash to execute the buyout.

Planning for transition

  • Only 6 in 10 firms report having a formal written plan in place.

Without the necessary funds in place when needed, a written plan is a worthless document. Very few of these firms have any plans in place should the owner suffer a critical illness or disability. Many partnerships have taken the time to draw up a formal plan to deal with how the ownership interest should be handled should a partner pass away or become disabled. However, only a portion of these businesses have completed the funding arrangements necessary to successfully complete the transaction. 

When one considers the additional risk of disability or critical illness, a more comprehensive plan is necessary. One of the services we as licensed professionals can offer is aiding in constructing a written plan that will provide funds when they are needed most.

How will the small-business owner fund their transition plan?

  • Pay cash
  • Borrow funds
  • Installment payments
  • Insurance

Buy-sell agreement

Under this arrangement, each surviving shareholder or partner agrees to buy the interest of any deceased business owner.

Partner A

  • Partner A purchases a life insurance policy on Partner B
  • Partner A is the owner, payor and beneficiary of the policy
  • Partner B is the insured

Partner B

  • Repeats the procedure

If Partner B dies, becomes disabled, or suffers a critical illness:

  • The policy will pay Partner A a benefit.
  • This benefit will be used to buy out the heirs of Partner B.
  • Partner A would then own the business outright.

Benefits of a buy-sell agreement

Creates an instant market for the deceased share of the business.

  • Commits seller and buyer
  • Provides for immediate liquidity
  • Locks in sale price
  • Sets estate valuation that may be binding with IRS

Business remains under control of remaining owners.

  • Protects the value of the business
  • Directs an orderly transfer of the business
  • Provides stability for customers, employees, creditors, and investors
  • Is simple to set up and maintain

What is the next step?

You will need to acquire some additional details to begin designing a custom plan that does the best job of solving the unique needs of your small business owners.

Once you’ve gathered the necessary information and analyzed it carefully, then present a number of options for the small-business owner to consider that address the concerns they have.

At that time you can help your small-business owner clients decide which solutions best fit their business needs and then begin to implement their plan.

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