Tips from Dr. Finance on Mastering the Art of Business Planning

Having been in touch with many SME business owners. I came to realize that Singapore has been encouraging entrepreneurship and creativity, and I'm glad the effort has paid off. More and more of the younger generation are heading towards starting businesses and making innovative ideas work. Then comes the next step, how can business owners take precautions to ensure a solid business plan is in place so that that the company's finances do not get endangered? Afterall, it's the hard work and effort of the business owner and I'm sure these owners (if you are one of them, reading this post), do not want their legacy to end just because of a lack of business planning!

For businesses in Singapore – whether SMEs or MNCs – group life insurance and commercial general insurance plans are commonly used in business planning (at least on the financial aspect). Generally, these types of plans provide a certain level of financial security for employees and their families.

But not many people would have realised this - these protection plans may not be adequate to protect the business from unforeseen risks or provide enough financial security for business owners and their key executives.

  Photo by Andreas Klassen on Unsplash

I would assume you’re reading this because you are currently a business owner or are intending to start a business in the future. Most business owners are familiar with managing the multiple risks that face their company. They have probably purchased casualty insurance, liability coverage and workers’ compensation, but have not protected their most valuable asset—the owner and key employee(s) – who would contribute the most to the business. The purpose of this article is to provide insights on the financial risks that business owners (especially SMEs) face and how life insurance not only can protect against those risks, but also provide additional non-qualified benefits for key executives.

A survey last year of UK finance directors, found that 55% of them did not have business risk management plans in place. In Singapore, 50% of SME businesses are at risk of not being adequately insured against the loss of their keyperson, according to a survey by United Overseas Bank. The  UOB small business survey have also found that while the majority of small businesses recognised the financial impact of losing their key person, they had yet to take action to protect their company against the loss of revenue and profit should their key person leave. As a result, many fail due to lack of risk management. Here are the 2 main potential risks that a business owner needs to consider and plan for to keep their business legacy alive: Keyperson Insurance and Business Succession.

Business Legacy Planning Concept #1: Life Insurance to Protect the Key Person

A lack of comprehensive business planning, particularly in the financial aspect, can create significant challenges when a key person—whether it's you or a member of your top management team—departs. This departure can also pose difficulties for those expected to step into these crucial roles. Key person insurance safeguards the business against the financial impact of losing a key executive or contributor, ensuring that the company can continue operating smoothly even after a significant loss.

For small to medium-sized enterprises (SMEs), the loss of a key person can disrupt sales, damage creditor confidence, and strain customer relationships. Key person insurance (often in the form of life insurance) provides the necessary liquidity to replace lost revenue, cover unexpected expenses, and stabilize operations. Moreover, the insurance proceeds can assist remaining shareholders in buying out the key person's estate. These plans typically require minimal administration and function similarly to personal life insurance policies, making them a practical and essential component of business legacy planning.

Business Legacy Planning Concept #2: Life Insurance for Business Succession and Buy-Sell Agreements

Beyond the immediate loss of a key person, businesses often face substantial costs in recruiting and training a suitable successor. Life insurance can offer the financial breathing room needed to find and train the right individual. As an old Chinese proverb wisely says, "The best time to plant a tree was 20 years ago. The second-best time is today." Succession planning should ideally begin at least five years before a key person plans to retire or semi-retire, although starting even earlier is better.

A successful successor should be a highly qualified talent with a deep passion for the business, capable of driving it to greater heights over the long term. Proactive planning ensures that the incoming talent has enough time to gain the necessary experience and skills in areas such as client services, strategic planning, practice management, and business development. Additionally, this foresight allows the company to make any necessary infrastructure adjustments.

In the event of a key person's demise, life insurance can also play a crucial role in a legal buy-sell agreement. This agreement, which should be established with the help of a lawyer, dictates how ownership of the firm will transition upon the death of a co-owner. Often, the surviving owners will need funds to buy out the deceased owner’s share of the business. This agreement ensures the future of the business is managed by the desired parties, preserving the key person’s legacy. Life insurance serves as the funding mechanism for this plan, enabling surviving co-owners to use the death benefit to finance the buyout. These agreements can be customized based on the business's structure and value, making them a vital tool in protecting business continuity.

Failing to plan properly puts the business at risk of folding, jeopardizing the hard work and passion invested by the key person and shareholders. Without succession planning, owners may exit the business without realizing its full value, which can severely impact business contingency and growth—outcomes no investor or key person wants.

Financial Instruments for Business Legacy Planning

For the purposes of this article, I assume that the basics of business planning—such as commercial general insurance, liability, fire insurance, workmen’s compensation, and group hospital/accident insurance—are already in place. These elements are akin to the icing on a cake. But what about the core layers? As emphasized earlier, the protection of the key person and ensuring solid business succession plans are the foundational elements of business legacy planning.

Two common financial instruments used in business legacy planning are term insurance and whole life insurance. Both fall under the broader category of life insurance.

Term insurance is the simplest and most straightforward form of life insurance. Similar to personal term insurance, it provides pure insurance protection for a specified period. In Singapore, a common scenario involves purchasing a level premium policy for a set duration—say, 10 years. As long as the premium is paid and the policy is in force at the time of death or terminal illness, the insurance company will pay the death benefit to the designated beneficiary. There are many ways to ensure the premium payment for such insurances to be tax-relieved upon the death of that key person or shareholder. For SMEs, term insurance is ideal when the objective is pure death/terminal illness benefit protection. However, since term insurance does not accumulate cash value, it is not suitable for deferred compensation or supplemental retirement plans requiring cash accumulation.

Whole life insurance offers another approach to ensuring business protection. Unlike term insurance, whole life insurance covers the key person for their entire life, not just a fixed term. Although premiums for whole life insurance are generally higher, they offer guaranteed death benefits and, in some cases, guaranteed cash value through interest rates or declared bonuses. Do note that generally, whole life insurance is not tax-deductible in Singapore.

The first type of whole life insurance typically insures your business for an amount of less than SGD $1 million. This "standard" whole life insurance usually has a break-even period (when cash value exceeds total premiums paid) of 20-30 years.

A more sophisticated option is universal life insurance, which provides flexibility to change the key person insured and allows for premium financing instead of upfront payments. Universal life insurance offers all the benefits of standard whole life insurance, plus a higher guaranteed cash value. The break-even period is typically around 7 years, and the policy allows for partial withdrawals of the prevailing cash value—a feature unique to universal life insurance.

In conclusion, I hope this article has enhanced your understanding of business planning, especially if you’re a business owner looking to improve and safeguard your enterprise. The mantra "If you fail to plan, you plan to fail" is something I live by and advocate to my clients, both in personal financial planning and business continuity planning. Remember, insurance is the only guaranteed financial tool that can add value to your business and protect it from potential failure.

To better assist you with your business planning needs—whether it’s life insurance, commercial insurance, or group insurance—I would be delighted to meet with you over a cup of coffee to understand your business and discuss your concerns.

Winifred Tan (Wini)
B.Sc (First Class Honours)
ChFC (Singapore) | AEPP | IBF Advanced Level 2CFA (Singapore) - L1 | CIPM (Int’l) Level 1
Court of the Table | Int’l Dragon Awards (Bronze) | APAC Financial Services Star Award
Top 20 GE Executive Financial Consultants | Entre-Planner