How business protection helps with succession planning

When it comes to planning for the future, many business owners will feel secure having money in the bank to cover any potential hires or even to use on the acquisition trail.

But what happens if that cash is called upon in the short-term, such as to compensate for the loss of a key partner or person in the firm?

It may be that clients have enough cash in the bank to cover any potential issues around replacing key personnel.

In 2016, it was pointed out that many companies – from FTSE 100 banks down to micro-businesses – had not only built up any cash buffers required by legislation but also had over and above their target limit.

If your firm and those of your clients have 30 per cent realisable cash, then perhaps there is no business imperative to buy protection. 

But while this sounds positive, it must also be remembered that Mike Cherry, chairman of the Federation of Small Businesses (FSB), warned earlier this year that 50,000 small and medium-sized businesses go under each year because of late payments alone.

There is clearly a huge opportunity for intermediaries in this market, so why aren’t more of them entering it? Richard Kateley

Moreover, 80 new companies were born every hour in 2016, according to FSB figures, most of which will not have had the time or the market share to build up sufficient cash buffers.

Andy Simmons, senior protection specialist for Vitality Life, states: “With the rise of the gig economy, more people are becoming self-employed and starting new companies. 

“The role of business protection has never been so important.”

It therefore stands to reason any sudden costs due to the death or illness of the owner or key person will need to be covered somehow to ensure the continuance of the firm – either by a sale or part-sale of the business or goods, loans from the bank or through insurance.

Richard Kateley, head of intermediary development for Legal & General, comments: “In most business protection cases, it is small businesses that are set to benefit the most.

“The engineering company on your trading estate, the payroll firm or the retail shop on the high street. In many cases, business owners are no different than an adviser’s individual clients. The firms they run might even be no different in size to the adviser’s own.”

Sole traders

For the sole trader who does not intend to pass the firm onto another, Tom Conner, director at Drewberry, says business protection might not always be appropriate.

This is because, generally, the firm would be wound up anyway on the death of the sole trader, so there would be less need for business protection to help with succession planning.

Moreover, if the sole trader has plenty of cash in the bank to cover any immediate concerns that might crop up, this again makes the need for specialist business protection policies less obvious.

However, he adds: “You could use a small KPI policy to help pay for the winding up of the business in an orderly manner.”

Key person and succession

For Mr Conner, key person insurance (KPI) is “all about smoothing the path for the business should the worst happen and a key individual becomes critically ill”.

KPI, as discussed in article 2 of this guide, whether through a life assurance, critical illness or an income protection plan – or even a mix of all three – can provide a cash injection (a lump sum or a flow of income) to the business if a key person dies or suffers a serious illness or injury.

Founder key person cover is important because it could mean the death of a business should the founder himself or herself die, unless steps have been taken to avert the problem through setting up a properly financed replacement strategy.

Healthcare can also help with rehabilitating key staff back to work and mitigate the costs of replacing a key person, thereby reducing the necessity to provide a suitable successor. 

Mr Moulton adds: “While health insurance may not provide a financial cushion as others forms of business protection may do, by doing a job of prevention and helping to keep employees well and working, healthcare cover may help to lessen the likelihood of the unexpected loss of key employees.”

Moreover, a good healthcare package, according to Mr Moulton, could also help recruit and retrain key personnel.

Six ways key person cover can help with succession planning

Drewberry has compiled a short list of ways in which potential problems around succession planning or replacing a key member of staff can be mitigated through key person insurance (KPI). These are: 

• Paying for recruitment/training costs for a replacement.
• Compensating for lost profits due to the key person’s absence.
• Compensating for a loss of knowledge about key business processes.
• Covering losses arising from lost business contacts.
• Difficulties in raising finance for new developments.
• Repaying outstanding loans/investments/venture capital injections.

Shareholder protection

Shareholder protection can also help with succession planning. Mr Conner elucidates: “With shareholder protection, the issue is the family member who inherits the shares on the death of a shareholder might not have the business acumen or even the desire to run the company as the shareholder did.

“However, they could still be entitled to a slice of the profits. This can place a significant financial drain on the company.”

Moreover, if the inheritor decides to make money by selling their shareholding to a competitor or consolidator this could have “significant ramifications” for the future of the business, he adds.

By putting protection in place, this mitigates those ramifications by putting in place a series of legal agreements that set out how shares are to be managed if a stakeholder passes away. 

Opportunity

Research carried out by Legal & General into small to medium-sized enterprises and business protection, underscored what Mr Kateley has described as an “opportunity” for advisers.

Key findings from the research found: 

• Some 95 per cent of the 5.4m private companies in the UK have fewer than 10 employees.
• Less than half of these currently have a financial adviser.
• Some 89 per cent of SMEs taking out business protection did so because they were advised to.
• The main reason they never took it out was because they had ‘never considered it’.

Mr Kateley comments: “From our visits to advisers across the UK, some lack the confidence or experience of business protection to enter this market. 

“One of the biggest barriers is that they think they have no corporate clients, but are we really talking about corporations? 

“There is clearly a huge opportunity for intermediaries in this market, so why aren’t more of them entering it?”

Practicing what you preach

During a meeting with protection advisers, carried out a few years ago by one product provider, the head of intermediary distribution at that company asked how many of them recommended business protection products to their clients. 

According to him, nearly 60 per cent of those attending (roughly 70 people in total) put their hands up. Then he asked how many of them had taken out business protection for their own firms, on top of any professional indemnity insurance. 

Three put up their hands, a few others said their network was covering them, and about 10 said they had income protection, but not business protection.

This isn’t confined to one providers’ experience, however. Johnny Timpson, protection specialist for Scottish Widows, comments: “In my experience, few advisers have protected their own business.

“In looking to tackle the significant protection gap we have in the UK, adviser firms looking at auditing their own business risks is perhaps a good place to start.”

He highlighted Paul Pickford’s video diary, which can be viewed on the Seven Families Project www.7families.co.uk which explored the issues he faced after suffering a life-changing stroke at just 42 years old.

For Paul Moulton, small-medium enterprise director for Axa PPP Healthcare, however, most advisers are practicing what they preach.

He comments: “In our experience, many advisers walk the talk and provide healthcare cover for themselves and for their employees.”

This gives a very good foundation on which to build a conversation with a potential client about their protection needs.

Relevance to the adviser’s business

This does not mean advisers are unaware of the potential risks. As Emma Thomson, life office relationship director for Lifesearch explains, it may not always be completely relevant for them.

Ms Thomson says: “For many advisers, whether they have business protection as well as other cover depends on the business size, and if they feel it is relevant as far as business protection is concerned.

“The main questions they need to ask is about cashflow – this is king in business. Is this strong enough? Can they cover the debt, replace the key person or buy out another owner?”

But what about succession? If the adviser wishes the business to carry on, can protection help? 

Succession planning and the adviser

For advisers looking to bring new blood into the industry, there is already an uphill challenge. Since the Retail Distribution Review (RDR) of 2012, the number of financial advisers in the UK has diminished.

An academic report from Cass Business School in 2013 found that adviser numbers fell from 40,000 at the end of 2011 to 31,000 by the start of 2013.

The report at the time was not entirely positive that the market would rebound. It states: “We find the remaining financial advisers are unduly optimistic about their own business prospects in the RDR world. 

“However, we believe changes in the industry have as much to do with unfolding technological and competitive forces as with RDR itself.”

Indeed, since then we have seen the rise of robo or hybrid advice, with more offerings coming to the market from the US and Europe; an increase in the number of direct-to-consumer investment sites, persistent consolidation among both providers and adviser-distributors and a return to the low-level advice market from the banks, such as RBS and HSBC. 

There is a lot of competition out there for advisers’ traditional client base, and if a firm wants to maintain and grow not just over 10 years but the next 30 or 50, then succession planning is a business imperative.

Protection can help with succession planning – not just for financial advisers, of course, but also for the clients whom they advise.

Ms Thomson concedes: “If a conversation starts about succession, then ownership protection is the important back-up plan, for death or critical illness.”

Early exit (buy-out) or retirement of the senior director or business owner are other factors which can be planned for, but the death or accident or sudden illness of the key people or the business owner cannot be planned for.

“This is why protection should always be considered,” she says.

simoney.kyriakou@ft.com