Businesses, like people, go through lifestages. Successful, one-person companies grow to become smal...
Businesses, like people, go through lifestages. Successful, one-person companies grow to become small businesses. Ultimately they may continue to grow organically or be acquired by larger organisations. But how do you identify the key stages that a company might go through as it grows into a significant organisation? How do the protection needs of a business change and how can IFAs target these needs at each key stage of development?
For our purposes we have identified the key stages of a business as sole trader, a small to medium-sized company (up to 20 employees) and medium to large organisations.
Local business directories list names and addresses of companies. But how do you know if they are potential clients for protection? Identifying those businesses that could benefit from protection insurance will involve a thorough understanding of the way the business is set up and its financial profile. A good starting point would be the memorandum and articles of a limited company or the partnership agreement, if there is one.
These will identify the liability of each shareholder and the amount of money each partner has put into the capital account respectively. Business plans will also give an indication as to how the business sees itself developing in the future.
Financial analysis of the report and accounts will provide a feel for the financial health of a business. Its progress over a period of time will come to light from the profit and loss accounts while the balance sheet will give a financial snapshot of its overall position. Loan details are given here, with information on the basis on which loans are secured, the notice period required and what is being held as security. If they can be recalled easily following death or long-term incapacity, they will need protecting. In general, the higher the gearing of the company the greater the need to protect its assets.
Similar information on partnerships and sole traders is likely to come from their business advisers. This analysis will provide a good picture of what the issues are for the business - whether, for example, it needs to protect a loan as well as key personnel. From this it should be possible to determine what cover is required and to what level.
For larger organisations, profitability is an important factor as it is an indication of the company's ability to provide benefits for its staff and directors and financial protection for the business.
Being aware of the total payroll of a business will give an indication of size and the scope for providing benefits packages. Age can be helpful. A well-established company may be in a strong financial position and more able to consider benefits packages for employees. A younger company may still be dependent on the performance of its founder, making it more vulnerable to collapse if that person dies or becomes incapacitated. Keyperson cover is therefore a consideration.
From little acorns...
Many small businesses invariably start out with one person, a sole trader. In essence, that person is the business and due to this status there is little distinction between private and business assets. Consequently, the cover they are most likely to need is life cover, critical illness cover and income protection - basically, money to protect the family.
As the business grows and takes on more staff, the protection needs shift in emphasis from purely personal protection to a mixture of both personal protection and cover to ensure the business can continue should the worst happen.
Small businesses are generally classified into two categories - limited companies or partnerships. While the protection needs are essentially the same, the different legal status of these businesses affects the way the cover can be set up.
Limited companies have a separate legal identity where shareholders have a limited liability up to the nominal value of the shares they hold in the business. In contrast, a partnership does not exist as a legal entity, except in Scotland. This is an arrangement where two or more people carry on business in common with a view to profit. Partnerships are governed by an agreement, that sets out the amount invested by each of the partners.
For both these businesses there are financial issues to consider if the owners either die or become seriously ill or incapacitated. The key area of concern is what happens to the ownership of the business, generally referred to as share protection. Keyperson cover and loan protection also need to be considered.
Share protection schemes are designed to overcome the problems that arise if a shareholder or partner dies or becomes seriously ill. On the death of a shareholder, for example, the shares will normally pass to dependents. In such a scenario, cash may be required to buy the shares from the family. Such arrangements are usually accompanied by an appropriate agreement and invariably the attaching policies are subject to trust arrangements. For example, a flexible, carve-out trust would ensure the monies went to the right people at the right time. In addition, this retains an element of flexibility so that as the business grows it allows for changes in ownership.
Keyperson cover is appropriate where the business can identify one or two key individuals who can affect the commercial viability of the future if they were not there. Cover will need to be reviewed regularly to ensure it is appropriate for the needs of the business. Keyperson cover for employees may also need to be considered as many partnerships now rely on practice managers to take care of the day-to-day running of the business and as such can be considered 'key'. This will invariably need to be put under trust due the legal status of a partnership.
Loan protection is designed to ensure that any outstanding debts are met if a director dies.
For these types of small business protection, the tax issues are complex, so this is a key area where the IFA can add value.
Transition period
When a company employs around 20 or more people it makes a transition into the arena of having to seriously consider employee benefits for those other than the owners or main shareholders. It must begin to look for ways in which to attract, retain and motivate staff, realising that employees often seek more than a wage packet from employers of a certain size. IFAs looking to exploit this transition period would do well to seek out industries where employees and their skills are at a premium, for example the information technology sector.
Just as the pattern of work is changing from the tradition of nine to five, five days a week, so too are employee expectations and financial awareness. Similarly, whereas private medical insurance may well have been satisfactory as part of a package of perks in the 1980s, employees are now more knowledgeable about what they may or may not need in their old age, for their families and themselves in the event of death or ill health. Employees are beginning to look to their employer to fill the gap left by the State in welfare provision.
One should consider also the way in which many employees in larger organisations are changing. Their lives are increasingly stressful, and while they may have financial security, they too are seeking more.
The State has left a gap in welfare provision that can be filled by insurance products and financial advice. However, societal changes mean that there are no extended families to rally around when a death occurs, no wife at home to look after the husband or go out to work (they may already have a high mortgage and be relying on the wife's income already) if he gets ill. This, coupled with the fact that what State provision is left is inadequate, means the employer has to fulfil both a financial and social need.
Employees are looking for flexibility in their benefits just as they are looking for flexibility in work patterns. They want choice and a benefits package that meets their needs as their circumstances and responsibilities change. They are looking for the employer to offer the sort of added benefit that they get from their supermarket - the benefits of bulk buying, loyalty schemes and added value. They are looking for a financial payout in a time of need, but also moral and practical support, for example, information and advice about what exactly to do with a £50,000 lump sum on having a heart attack.
Professional advice and careful selection of product and service providers can play a role here, such as in negotiating bulk benefits for a voluntary package, providing communication tools or in looking for an insurer that will offer helplines and after-care services.
As companies undergo various lifestages, their protection needs change from pure business protection to employee benefits provision as part of a comprehensive HR strategy. IFAs should be there to support the business's needs through every stage of development.
Rosalind Pearson is personal finance research and planning manager and Nicola Smith is employee benefits marketing consultant at Swiss Life
