Determining Key Employees’ Value to Your Business
Posted by: Linda Kay | April 28, 2014
As a business owner, you know that a handful of your employees are vital to the success of your business. Don’t forget to include yourself on that list as well. So, what happens to the business if any of your key employees are disabled or dies? Most of the time we really don’t want to think about that sort of disaster. What if you take a few minutes to put a plan in place to deal with this issue, then you can move on to the more pleasant parts of your business?
Some of the situations that insurance can address are:
- Indemnify the business for the loss of a Key Employee
- Address the financial consequences of an Owner or Key Employee’s disability
- Guarantee business loan repayment at the Owner’s death
Determining Employees’ Value
The first step in developing your plan is determining the “value” of the employee. These are the formulas, or "yardsticks," most commonly used to measure a key employee's value to a business:
Capitalization of Salary. The value of the key employee is measured by multiplying his or her annual salary by a capitalization factor that ranges from two to ten. The more critical the key employee's contribution to business success, the higher the capitalization factor used.
Contribution to Earnings Method. One method is to assign value to the key employee's annual contribution to earnings, which is then multiplied by the years it is assumed will be required to replace the key employee's expertise.
Present Value of Contributions to Earnings. This method assumes that life insurance proceeds can be invested, with both the investment return and insurance proceeds used to indemnify the business on an annual basis, beginning at the key employee's death, for the annual loss of the key employee's contribution to earnings.
Replacement Cost. The value of the key employee is pegged at the estimated sum required to replace his or her contributions to the business.
One Year’s Profit. With this method, the key employee is insured for an amount equal to one year's profit, which buys the business a year to locate and train a replacement.
As an independent agency, Dean & Draper offers an array of policies. We would like to visit with you, understand your business and needs, and develop a plan specifically for your situation. We will present a proposal designed to meet your specifications. We’re only a phone call away.
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