Dan Sudit wishes that more financial professionals would make sure that business-owner clients have prepared for the possibility that they could suddenly die or become disabled.
Sudit, a partner at Salt Lake City-based Crewe Advisors, a financial advisory firm, has not seen sudden transitions related to death or disability occur very often, but the ones he has seen have left an impression.
He thinks that an owner needs a succession plan, along with careful thinking about key-person life insurance and disability insurance.
"If a family has the right insurance, and it's set up correctly, as far as ownership and beneficiaries are concerned, and the key-person insurance agreements are tied to business operating agreements, it works well," Sudit said.
"It's more often the case that people get sold the insurance but often never get around to addressing the formalities associated with the purpose of the insurance in the first place," Sudit warned. "Or, people buy insurance and don't pay attention to the administrative aspects of the policy and its intended purpose."
Sudit answered questions about the role of key-person insurance in succession planning via email. The interview has been edited.
THINKADVISOR: What situations come to mind when you think about crisis-related succession planning?
DAN SUDIT: Two different instances.
One was a smaller manufacturing company in California where the owner was selling his company, planning a transition to new owners (did not close on the sale yet), but he was in process. He was diagnosed with cancer and passed within months.
The second was an international telecom company where the president and CEO passed away in an airplane crash.
What happened to the manufacturer?
For the manufacturing company, it stopped the sale in its tracks.
There was no effective succession management plan. The business suffered. The sale finally occurred, but with a significant discount.
It was a very sad outcome for all.
In their instance, it was a typical mom-and-pop business that grew into a large manufacturing concern but was still run by one person at the top.
There were lieutenants, so to speak, but none of them were privy to or involved in the real guts of the enterprise. It was all owned by the family, yet neither the spouse nor any of the kids were involved.
The buyers of the business understandably got cold feet and backed out of the deal.
It took months for the family and existing employees to try and stabilize the company. They ended up selling it to the original buyers but for a fraction of what the buyer originally was going to pay.
The obvious disconnect was continuity of management and leadership.
All too often, family-owned businesses can't differentiate between ownership, management and leadership. What they fail to realize is they can all coexist and can be mutually exclusive of one another.
If you have a successful and growing enterprise, you should have leadership who can run the business, is incented to effectively run the business, and does not necessitate diluting ownership to others outside of the family.
There are various ways to create compensation and incentive structures with non-family members to align their goals with those of outside leadership that results in effective succession planning for management and leadership that does not adversely impact the equity stake of the family.
What happened to the telecommunications business?
This was a larger, multinational, publicly traded company that had thousands of employees, a formal management structure and board leadership.
Although the death of the CEO was unexpected and tragic, there was succession planning, other managers, and other leadership in place to carry the torch. Albeit, perhaps differently.
Do typical firms have good plans in place for dealing with those kinds of situations?
I would contend that most do not.
In the two cases I identified, there was no key-person insurance for their respective passing.
The death of the owner of the manufacturing company resulted in a direct impact to the value of the enterprise that was never recouped.
As for the passing of the telecom exec, that executive's passing resulted in a drop to the stock price as a result of this idiosyncratic event but, presumably, was made up as time progressed.
I would argue that most of the families we work with that are small or mid-sized business owners have no insurance to make things "right."
Or, if they do have it, the families are still woefully underinsured for a sudden passing. Most often, that's because it's not an immediate risk that the families worry about.
As the value of a family's enterprise increases, they often don't revisit the value of the policies they do have. Or said differently, their success often breeds complacency. They don't see the value in increasing the policy coverage to be commensurate with the higher valuation of their enterprise.
And it's worth noting that increasing the coverage limits isn't exponentially higher in cost. Rather, as I mentioned, complacency sets in. Most owners don't see the value.
What can a business owner expect to get out of having key-person insurance?
The goal is not for the insurance to be a windfall, rather part of designing an effective succession strategy to protect the ongoing enterprise, both from a financial perspective, so that a sudden transition that doesn't trigger undue hardship for the business itself, and from a management structure perspective, so that the insurance is also aligned with the needs of a management structure that includes people other than the key individual.
The individual's passing will understandably be a detriment and a pain to the business, where bouncing back is a process, but the business should be able to bounce back.
It should not result in crippling or collapsing a business entirely.
How can agents and advisors help?
I believe that whoever pitches the idea of getting the key-person insurance has a duty to ensure that, procedurally, once the policy is established, all aspects are properly and thoughtfully addressed, including ownership, beneficiaries, agreements, and updates to the business operating agreement, so this unfortunate event has been presupposed, and there is a structure for how to proceed as it relates to having the insurance achieve its objective.
Also, the key-person insurance has to be revisited regularly, as part of the ongoing management process.
What factors go into deciding whether a business owner's key-person coverage still fits?
If the value of the business increases dramatically, so should the insurance coverage.
If people other than the owner are playing a key role in the ongoing concern, are they covered as well? Is there a course of action for their unexpected passing?
All of these things have to be addressed on a regular basis.
Similar to homeowners' insurance, assume you have a policy that provides $500,000 of replacement coverage. Then you go and add a second story to your home, and upgrade your kitchen and bathrooms, and, also, add a pool and two dogs to the family.
Chances are, if you fail to address this and update your homeowner's insurance coverage, you will be woefully underinsured and, with the added liabilities of a pool and pets, may not have binding coverage at all, depending on the policy and circumstances of a loss or claim.
The point is, you need to ensure that your insurance is commensurate with your needs and circumstances as they evolve and change. If you don't address the changes, and the intended purpose of the policy, the policy becomes ineffective and, potentially, useless.
Credit: Syda Productions/Adobe Stock
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