Tesla and Elon Musk. Warren Buffett and Berkshire Hathaway. Jeff Bezos and Amazon. These are just three prominent examples of large companies and their famous ‘keymen’—people who can credibly claim responsibility for generating a lot of revenue and opportunities for their respective companies.
Imagine what these companies would be without them. Sure, they would all probably survive in the long run (perhaps except for Tesla). But there would most likely be short-term pain—very expensive short-term pain, especially given their publicly-listed status.
Consider that even the departure of less famous CEOs can result in significant costs to the company. Research by Morgan Stanley surveyed S&P 500 companies and found that, for 2017, companies whose CEOs left, saw their stock substantially underperform their peers. Their share prices increased an average of 4.9% during the year, compared to 15.4% for the entire market. 70% of companies with departing CEOs underperformed the market, with almost a third underperforming it by over 20%1.
Given that the smallest S&P 500 company has a market cap of over US$3 billion2, that underperformance translates to billions of dollars in forgone market value. This is no trivial matter.
Businesses often regard keymen as invaluable assets. This perspective makes sense, they are after all responsible for bringing a lot of revenues and other opportunities to the business. Yet, at the same time they also represent large contingent liabilities—things that may become liabilities depending on (contingent on) how certain events play out.
This paradox demonstrates the essence of keyman risk. People can become too valuable to a business, which makes the entire operation more vulnerable. If these keymen are no longer available—whether because of tragedy, health, better opportunities, or a change in priorities—these companies may be doubly hit; the first from the immediate operational disruptions and the second from future opportunities lost.
As the Morgan Stanley research report warns, “Investors should be increasingly aware of companies that face ‘keyman’ risk, or those that have a high level of reliance on a single individual”.
Large corporations are exposed to keyman risk—as the examples above demonstrate. But in general, their operations don’t rely so much on any one person. Despite the potential loss in market value and short-term shareholder pain, the underlying business will, in most cases, remain sound.
Not so at the smaller level. At this level, where businesses tend to be family-owned, keyman risk is often much greater. Publicly listed companies face greater scrutiny, which necessitates the implementation of more robust systems and processes. Few family businesses go public and are thus lacking in this area.
The impact of such risks is also amplified. For instance, what happens if the keyperson is also a substantial shareholder of the business? The remaining partners may then be faced with the prospect of dealing with an ‘undesirable’ shareholder. Yet, despite the greater threat keyman risks pose to these businesses, it is also often the most underestimated.
One major reason for this is that, at the family business level, there is often very little separation between the family and the business. Because of its beginnings, the family and the business remain too intertwined—the family is the business and the business is the family. Few want to broach the topic of planning how the business can mitigate the cost to itself if something tragic befalls a keyperson, who is most likely a family member. The needed detached perspective is lacking.
This dovetails with findings that many Asian family businesses, which make up the bulk of wealth in the region3, have inadequate 4. The reasons that cause an underappreciation of keyman risk—and the need for a sound business continuity plan—are the same that cause in this lack of succession planning.
Having said all that, what steps can such businesses take to mitigate keyman risks? We outline a three-step procedure companies can follow below.
The first step is identifying the key personnel within the business. In many cases, particularly in smaller businesses, the keymen are obvious, and this step is easy. But this is not necessarily the case for all. In some cases, key personnel may be less obvious. Here are a few questions to ask that can help pinpoint their identities.
Once a business has identified its keymen, it needs to quantify the risk to the business. This is a more complex step, as it can be almost impossible to obtain an objective value. But while at least part of this quantification will be inevitably subjective, this step is still necessary. Here are several gauges businesses can use to guide them through this step.
The third step is determining and implementing the risk management measures. There are two main ones we recommend—the right insurance policies and robust systems and processes.
Using universal life insurance policies
One simple way that many companies use to manage keyman risks is using universal life insurance policies. These policies are taken out by the company on the keyman; however the company remains the beneficiary. Such policies can then directly compensate the company for any direct or indirect costs incurred in case of any tragedy befalling the keyperson.
When looking for insurance policies to mitigate keyman risks, it is important to ensure that beneficiaries can be transferred at will. This gives the business the flexibility to use a single policy to cover multiple people that may fill a key role. For instance, if one keyperson retires, that same policy can be used to cover their replacement.
The death cover amount is another factor. For most businesses, the smaller sums available for the more standard mass-market policies is simply insufficient. This is what makes universal life insurance—where the death benefit can be structured to reach more—the most appropriate tool for this situation. For instance, with the scenario given in the Manulife Heirloom VI product brochure, a single upfront premium payment of US$7 million could potentially buy a policy with as much as US$20 million in death benefits.
Of course, choosing a suitable policy amount is crucial. Both going too high or too low can result in a lot of cost inefficiencies, which means taking the time and effort to properly quantify the risks as in Step 2 is vital.
Setting up robust systems and processes
Many small businesses scoff at larger corporates as being slow and bureaucratic, weighed down by the sheer number of systems and processes they have in place. And there is no doubt more than a kernel of truth in that perspective. But there is a reason that these companies have all these in place—they are essential to not only manage the complexities that come with greater organisational size but to mitigate risks just like keyman risks.
Smaller and family-owned business would do well to take this to heart. While universal life insurance policies are an effective tool for managing keyman risk, they work best as part of a larger framework of systems and processes. In this context, these should focus on ways to transfer or spread out the value that the keymen bring among other personnel.
There are too many variations between companies for us to recommend any specific systems and processes—they should be unique for each business, and there is no ‘one size fits all’ solution. Unlike going out and purchasing a universal life insurance policy, putting these in place will be more difficult. But it is a necessary step, and businesses who have yet to implement these should start as soon as possible.
Business Continuity Planning Protects the Company’s Flanks from the Unexpected
When times are good and business is doing well, a business continuity plan can sometimes slip down the priority list. This makes sense—after all, it doesn’t generate any revenue, and in fact, often costs both time and money to implement. But when the unexpected happens and a such a plan is needed, it may already be too late.
Insurance policies, particularly universal life insurance policies such as Manulife’s Signature Solutions, are an essential part of a sound business continuity plan. If you’re interested to learn more about how our solutions can serve as part of your business continuity plan, speak to one of our financial consultants today.
These insurance products are underwritten by Manulife (Singapore) Pte. Ltd. (Reg. No. 198002116D). This article has not been reviewed by the Monetary Authority of Singapore. Buying a life insurance policy is a long-term commitment. There may be high costs involved if you terminate the policy early, and your policy's surrender value (if any) may be zero or less than the total premiums paid. This article is for your information only and does not consider your specific investment objectives, financial situation or needs. It is not a contract of insurance and is not intended as an offer or recommendation to purchase the plan. You can find the full terms and conditions, details, and exclusions for the mentioned insurance product(s) in the policy contract.
This policy is protected under the Policy Owners’ Protection Scheme which is administered by the Singapore Deposit Insurance Corporation (SDIC). Coverage for your policy is automatic and no further action is required from you. For more information on the types of benefits that are covered under the scheme as well as the limits of coverage, where applicable, please contact us or visit the LIA or SDIC web-sites (www.lia.org.sg or www.sdic.org.sg).
We recommend that you seek advice from a Manulife Financial Consultant or its Appointed Distributors before making a commitment to purchase a policy.
3 EY Family Business Yearbook, 2017