Protect against the loss of workers who are crucial to your success.
If your business relies on great employees to make certain aspects of your company run well, they also probably represent an important part of your profitability. When a key employee is injured and unable to work for an extended period of time, or worse, if your employee dies unexpectedly, what would be the resulting impact on your cash flow?
Customer loyalty to your company is often strengthened by relationships with your key people. Banks and financial institutions are also likely to be aware of the importance of certain key employees to the profitability of your business. Suppliers who extend important terms for products you purchase are also watching to consider how your business will be impacted after such a loss. And aside from these financial concerns, the potential loss of leadership and expertise of key people can have a significant impact on company culture.
It is easiest to measure the cost to replace a key person’s efforts. Replacing that knowledge may sometimes require more than one new employee, especially if their job functions are varied. But the most difficult thing to replace is the positive influence and cultural fingerprint of that individual.
Hiring a replacement who fits your company culture may take time, therefore it is often easiest to consider a multiple of salary as the economic measure of an employee. If it is likely that you will go outside of your geographic area to find this person, then your valuation may need to include search fees, hiring bonuses and moving expenses.
A part of the owner’s and human resources officer’s responsibility may be to manage risks that might cause disruption. Some of these factors can be managed easily, and others cannot. Providing benefits that encourage healthy employees is important. Your company can provide health facilities, health club memberships, a clean and enjoyable work environment, health challenges and strong management support to reduce stress. You can even offer great behavioral health and wellness services (an excellent and inexpensive benefit), but even with these efforts risks still remain.
Support from Insurance
Insurance companies who provide products for the business market understand the importance of key employees. The use of inexpensive benefits such as short-term disability, long-term disability and individual disability insurance plans can help fund promised compensation benefits for recently disabled employees at a time when the cost to replace that individual’s efforts can cause significant and negative impact on your income statement. Separately, if an employee has died, the high cost of replacing that employee with one or more individuals can be mitigated using life insurance.
In a key-employee life insurance policy, the owner and beneficiary is the company, and the death benefit can be income tax free if owned properly. This can provide the necessary liquidity to replace that talent over a one- to two-year period and help protect against the loss of income during the time it takes to hire another quality individual who fits your culture. When the cash flow has been maintained, this may help give suppliers and lenders a sense of organizational stability.
The following is a simplified method to value key employee contribution.
- Basic income plus bonuses = 100 percent
- Greater than 10 percent impact to gross profitability = 100 percent
- Number of business areas they impact = x 10 percent (3 areas = 30 percent)
- Responsible for interacting with the company’s governing body = 20 percent
- Interact with lenders = 10 percent
- Manage interaction with suppliers = 10 percent
- Required to search outside of your immediate market to replace them = 20 percent
Add them and multiply this by their annual compensation to create a simplified benchmark for key employee value. For example, 210 percent x $80,000 (salary and bonus) = $168,000 of key employee value.
Although there are many ways to value key employees, you can see how important it may be to engage a qualified financial professional to help you think through the impact that a key employee loss can have on your business.
Katheigh Degen and Raleigh Lang are registered representatives of and offer securities, investment advisory and financial planning services through MML Investors Services, LLC. Member SIPC. Supervisory office: 1300 N Walker, Suite 200, Oklahoma City, OK 73103. Phone (405) 486-1400. Twin Financial, Inc. is not a subsidiary or affiliate of MML Investors Services, LLC, or its affiliated companies.