What is your most important asset?

“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:

Flexible

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

Valuable

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

 Cost-effective

• 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