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The death or serious incapacitation of a key person or director of a business could have dire implications for its cash flow and profitability.

The loss of key accounts or a significant drop in income due to such an event could cause a company to default on its loan agreements and/or put it in breach of the Companies Act.

The Companies Act 1993 makes the following requirements;
1. Liquidity Limb: The company must be able to pay its debts as they fall due during the ordinary course of business
2. Balance sheet Limb: The Company must have assets greater than all of its liabilities, including contingent liabilities.

Technically a company must be solvent at all times to remain in existence. The death or disablement of a key person may make it impossible for a company to meet this test.

Losing a key person may affect the companies' ability to meet its normal commitments under a loan agreement. The purpose of debt protection is to provide cash to repay external debt such as; loans, overdrafts, leases and H.P's, creditors and contingent liabilities, and internal debt such as shareholder advances and current accounts.

The risks commonly associated with triggering a default would be death, permanent disability and temporary disability. Questions to ask yourself are; what event could give rise to a default on your debt? What debts can be met from cash flow?

A careful analysis of a company's financial position should be able to reveal wether it could meet the above requirements. A review of who is responsible for generating revenue and servicing important clients or who has specialised knowledge or intellectual property will assist in understanding how that person/s loss would impact on the company balance sheet. Discussing what that outcome could look like with the directors/guarantors could be very revealing.

It is normal for a lender to request a personal guarantee when a business loan is advanced and many of these are joint and severable, meaning all guarantors are jointly and equally responsible for the total debt. A lender may recover the full outstanding balance from the surviving guarantor.

Consideration should also be given to how the premiums are paid, ownership of the policies and potential tax issues. This is something that your accountant and solicitor should be involved in. The impact on your buy/sell agreement should also be considered; should any debt payout be included as part of the valuation if it also triggered a buy/out under said agreement? What happens if there are surplus or insufficient funds? When is the personal guarantee released?

Debt protection insurance is designed to meet actual needs and should not be a windfall. Careful consideration should be given as to how this fits in with your overall business risk strategy. A good risk adviser should be a real asset in this area.

Written by Gerard Tilleyshort.