The world is unpredictable now the time to do Key person succession planning

Building enduring value into a business is every entrepreneur's dream, and a plan that clarifies ownership, control, and responsibilities when a senior position becomes vacant is essential.

For organisations of all sizes and at any evolutionary stage, a professionally structured succession plan reduces the chance of uncertainty and instability by avoiding stakeholder conflict, maintaining momentum, unlocking new management opportunities, and empowering the next generation.

In private companies, the close relationship between shareholders and the board of directors can quickly become contentious if the objectives and dreams of the founder are not aligned with the executive leadership team. This is especially true of board members appointed with specific skills such as marketing, legal or financial – and who feel compelled to take actions that are in the company's best interests rather than a shareholder. The succession plan can replace chaos with an order by providing clarity and direction and handing authority and control to the board.

In publicly held companies where relationships with numerous shareholders are less personal, the stakes can be even higher, and the many more moving parts make succession planning complex but significantly more important. Here, planning aims to line up positions strategically and develop new leaders to manage risk, restore stability and maintain growth following change.

In family businesses, although founders are motivated to fulfil their vision, it's not always the case that the next generation will embrace that vision or have the same passion for success. Preparing a successor for leadership requires discipline and the right balance in terms of knowing when to hold on and when to let go to ensure the focus remains on maintaining key customer relationships, quality control, preservation of company assets and harmony within the family unit.

Long-term planning and training of the succeeding generation are essential to ensure post-succession wealth management endures long after operational ties are severed. It may also be the case that retiring owners need to be sure that a family business will continue to provide them with sustainable cash flows after they've left, so professional tax and estate planning advice is crucial.

To preserve the value of the overall estate and avoid compromising the lifestyles of beneficiaries, many family business founders consider using life insurance to mitigate the inheritance tax liabilities likely to be faced by their beneficiaries.

A useful example of effective tax planning by Continental Advisors would be our 38-year-old Indian national client. He owns a family diamond and jewellery business in Belgium that trades across India, Belgium and Dubai.

The client approached Continental to plan future tax liabilities for the business, which has family-owned assets worth $26-28 million.

Initially, the client hoped to take a $10 million Life Cover policy from Manulife for 10 years. However, a shortfall in the value of his relevant personal income and assets reduced the available cover to $3.5 million. Continental's advisor was able to negotiate $5 million of cover from both Sunlife and Manulife.

By anticipating the estate's growth in coming years, our advisor was able to structure the insurance policy to ensure that $10 million of any inheritance tax liability would be met without the need to liquidate any of the family estate's assets. As a result, the family's lifestyle would not be compromised.

If the challenge of getting succession planning right was already difficult pre-COVID, then it's considerably more so now, with talent scarcer than ever. Many people hunkered down during the pandemic rather than grapple with the uncertainty of a new job in a year that was already so unpredictable. As a result, much of the HR turnover that might naturally have occurred in 2020/21 didn't, and the backlog of key team members who may now be seeking new challenges presents an alarming business risk.

Employee health and mental well-being can also change immediately and have rightly been brought under the post-pandemic spotlight. It, too, can significantly impact a team member's availability to step into new leadership positions. Succession planning that actively engages key talent and promotes resilience puts businesses in a much better position to weather the post-pandemic churn.

Key person insurance is among the many elements of an effective succession planning strategy. This uses the term critical illness cover to de-risk the potential financial impact of the sudden departure of a business owner or pivotal team member.

It's the company that applies for key person life cover, pays the premium, owns all rights in the policy - including any cash values in the plan, and is the beneficiary. The company collects the death benefit if the key employee dies while the policy is in force. It can use the proceeds to meet short-term obligations as well as to recruit, hire and train a qualified replacement, protect the company's credit position, fund a stock redemption, replace lost profits, or make survivor benefit payments. These funds are treated as an addition to the surplus, and income is tax-free.

To insure a key employee, a company must quantify the monetary loss it would face if the employee died. While computation criteria exist, employee valuation remains something of an art rather than an exact science. The four most common approaches are income multiples, profit contribution, business discount and business life value. Aside from term life cover, key person disability insurance is designed to protect the company or business if a key employee is disabled through injury or illness.

More complex policies are used where a buy/sell agreement is in place in the event of the death of an owner or business partner. A key person life policy on each owner provides immediate cash to buy out the deceased partner's business share. Using life insurance to redeem a deceased owner's equity also has the advantage of relatively inexpensive costs compared with the alternatives to funding a business buy-out.

We can see then that the process of succession planning broadens horizons by forcing organisations and leaders to make time to think about the future and the changes that need to be made to secure it. Developing answers to succession planning questions doesn't just help with future personnel issues, it's part of setting a smart course for an organisation's future.

Succession planning can be complex, however, with scenarios and solutions as diverse as an organisation's needs. Therefore, Professional advice is essential, so talk to a Continental Group advisor to understand the benefits of methodical planning. Everything we do is driven by the philosophy of building long-term, mutually beneficial relationships with our customers based on providing personalised solutions through our qualified and experienced team of consultants.